ISRAEL ELECTRIC - iec.co.il · ISRAEL ELECTRIC CORPORATION LIMITED FILES INDEX ... 1975 (“the ......

ELECTRIC ISRAEL CORPORATION LIMITED

FILES INDEX – Part I

The financial reports, for the year ended December 31, 2009, are presented in a primary order. Each chapter is numbered separately by its internal sequence.

Part I Chapter A - Description of Corporate Business.

Chapter B - Board of Directors' Report on the Status of the Corporation's Affairs. Supplement - Additional report regarding the efficiency of the internal controls on the financial reporting

ISRAEL ELECTRIC CORPORATION LTD

CHAPTER A: DESCRIPTION OF CORPORATE BUSINESS

FOR YEAR ENDED

DECEMBER 31, 2009

2

Prominent Disclaimer

This English translation of the "Description of the Corporation's

Business Affairs for the year ended December 31, 2009" ("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,

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.

3

Table of Contents

Section A: Description of Corporate Business

1. Description of the economic development of Company business .......................................4

1.1 Company activity and description of business development .............................................4

1.2 Chart of the Company's Holding Structure ........................................................................5

1.3 Areas of Activity .....................................................................................................................5

1.4 Investments in Company capital and dealings in its shares...............................................6

1.5 Distribution of dividends .......................................................................................................6

1.6 Financial information regarding areas of Company activity (In millions of NIS adjusted to December 31, 2009) ............................................................................................8

1.7 General environment and effect of external factors on Company activity.......................9

1.8 Electricity rates.....................................................................................................................52

2. Matters Relating to Each Activity Segment Separately .................................................70

2.1 The Generating Segment .....................................................................................................70

2.2 The Transmission and Transformation Segment............................................................105

2.3 The distribution segment ...................................................................................................115

3. Description of the Company’s business - matters pertaining Company activity in general...............................................................................................................................129

3.1 Information on Business Initiative ...................................................................................129

3.2 Insurance and risk management.......................................................................................130

3.3 Customers - consumers of electricity ...............................................................................132

3.4 Marketing and distribution...............................................................................................133

3.5 Seasonality...........................................................................................................................133

3.6 Research and development................................................................................................134

3.7 Human resources (see Annexes E, F and G below).........................................................136

3.8 Fixed assets and facilities...................................................................................................147

3.9 Working Capital .................................................................................................................149

3.10 Financing.............................................................................................................................149

3.11 Taxation...............................................................................................................................152

3.12 Restrictions and regulation of corporate activity............................................................152

3.13 Trade Restrictions Regulations.........................................................................................161

3.14 Material agreements ..........................................................................................................164

3.15 Legal proceedings...............................................................................................................165

3.16 Strategy and objectives ......................................................................................................165

3.17 Discussion of risk factors ...................................................................................................166

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1. Description of the economic development of Company business

1.1 Company activity and description of business development

The Company was incorporated in Israel on March 29, 1923 with the main purpose of generating,

transmitting, distributing, selling and supplying electricity to all consumers.

The Company was registered under the name The Palestine Electric Corporation Ltd., which in 1961

was changed to its current name, The Israel Electric Corporation Ltd.

Soon after its establishment, the British Mandatory Government in Palestine gave the Company a

concession known as the Jordan Concession, and assigned to it a concession known as the Yarkon

Concession (which was originally granted to Pinchas Rutenberg). By virtue of these concessions the

exclusive right to generate, supply, distribute and sell electricity all over Mandatory Palestine,

excluding Jerusalem and its surroundings was bestowed upon the Company.

These concessions were ratified by the Electricity Concessions Order, 1927 ("The Electricity

Concessions Order"), that was published in chapter 52 of the Laws of Palestine (“the concession” or

“the concessions”).

The validity of the concessions granted by the Electricity Concessions Order ended on March 4, 1996,

and since March 5, 1996 the Company has been subject, among others, to the provisions of the

Electricity Sector Law – 1996 ("the Electricity Sector Law") which has been amended several times,

since its enactment. The Electricity Sector Law can be seen on the Internet site of the Public Services

Authority - Electricity (“the Electricity Authority”), at www.pua.gov.il.

Regarding the structural change required by the provisions of the Electricity Sector Law and the

Company’s preparations for its implementation, see sections 1.7 and 3.17c below.

Regarding the organizational restructuring of the Company ("Matzpen Plan") see section 3.7.4

hereunder.

The Company is owned by the State of Israel, which holds about 99.85% of its shares, and therefore

the Company and its activities are subject to the Government Companies Law – 1975 (“the

Government Companies Law”). In the Companies Law – 1999 (“the Companies Law”), the definition

of “public company” was changed and currently, pursuant to Amendment No. 3 to the Companies

Law, the Company is defined as “a company whose shares are registered for trading on a stock

exchange or were offered to the public in a prospectus within the meaning of the Securities Law, or

offered to the public outside Israel, according to the public offering document, required by laws

outside Israel and are held by the public.”

On February 7, 2005, following the Company’s request to the Government Companies Authority ("the

Companies Authority") to clarify the issue of its status as a public or private company, the Company

received an opinion from the legal advisor of the Companies Authority, indicating that in the opinion

of the Companies Authority, the Company is a public company within the meaning of the Companies

Law. According to the opinion, the fact that it was not possible to identify with certainty the origin of

shares held by the public did not justify denying the protections granted by the Law to the public

shareholders, and the burden of proof lay with the Company to show that all such shares actually

originated from private issues.

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In light of Amendment 3 to the Companies Law and the changed definition of “public company” in

the Companies Law and in view of the opinion of the legal advisor of the Companies Authority, the

Company is operating as a public company.

1.2 Chart of the Company's Holding Structure

* Other inactive subsidiaries and secondary subsidiaries of the Company are excluded from the chart.

The Company also has minor and negligible holding (almost zero holding rate) in the following

companies: Israel Chemicals Ltd., Binyaney Ha'Uma Ltd., and The Farmers Company in Israel Ltd.,

as well as the government company, Mekorot Water Company Ltd. Please note that the Company

includes the National Coal Supply Corporation Ltd., in its consolidated financial statements.

1.3 Areas of Activity

The Company operates as one coordinated and integrated system engaged in the provision of

electricity, from the electricity generation stage through transmission, distribution, supply and trade.

The Company is also engaged in construction of the infrastructures required for the aforementioned

activities. The Company’s activity covers three main segments of activity1 :

1 Note that the sectors of activity according to the Electricity Sector Law also include system management, supply and

trade in electricity.

99.98% 50% 100%

Advanced Studies Fund of Israel Electric Corporation Ltd.,

Employees

Jordan Properties Company Ltd.

Israel Electric Corporation Ltd.*

National Coal Supply Corporation Ltd.

6

1.3.1 Electricity generation, including all activities involved in the generation of electricity at the

Company’s sites (see sections 2.1.1 and 2.1.15 in this report).

1.3.2 Electricity transmission and transformation, including transmitting electricity from generation

sites along ultra high and high voltage cables to switching stations, and between switching stations

and sub stations, over high and ultra high voltage lines using transformers (see sections 2.2.1 to

2.2.11 in this report).

1.3.3 Distribution of electricity , including sending electricity from sub stations to consumers over high

voltage lines and low voltage lines, and supplying and selling electricity to consumers (see sections

2.3.1 to 12-2.3.1 in this report).

For financial information about the Company’s areas of activity, the principles and the results of

allocation of statements of operations and balance sheets according to operating segment, see

section 1.6 in this report and Notes 34 and 38 to the Company's Financial Statements as of

December 31, 2009.

Although pursuant to the provisions of the Electricity Sector Law, the Electricity Authority defined

for the Company separate rates for the different segments of activity, nevertheless most consumers

of electricity pay one weighted rate for their electricity, which includes all segments of activity.

Therefore, matters relating to Company customers, seasonality, human resources, research and

development, working capital, financing, taxation, objectives, business strategy and risk factors are

described with reference to the Company as a whole (see sections 3.1 to 3.17 in this report).

1.4 Investments in Company capital and dealings in its shares

To the best of the Company’s knowledge, there were no material dealings in its shares in the last two

years.

1.5 Distribution of dividends

a) The policy of the Companies Authority on payment of dividends

1) According to the provisions of section 33(c) of the Government Companies Law, a Board of

Directors decision regarding the appropriation of earnings of a Government company,

including distribution as defined in the Companies Law, must be approved by the

Companies Authority; if the Companies Authority disagrees with the Board’s decision, then

a company of the same type as the Company (so long as it is not undergoing privatization)

shall act in accordance with the decision of the Companies Authority (as approved by the

Government).

2) The current policy of the Companies Authority (which may change from time to time) with

respect to the appropriation of earnings to payment of dividends, from 1995 onwards,

divides the earnings from which dividends will be paid into two types:

(a) Dividends from current earnings will be paid in public service companies, equal to 60%

of the annual net current income, before payment from earnings of bonuses to

employees.

(b) Dividends from cumulative earnings will be determined for each company specifically,

taking into account the instructions of the company's incorporation articles, the

instructions of the law and a number of relevant facts, including investment

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requirements for the next few years, liquid resources, cash accumulated, cash flow,

financial leverage, working capital requirements and possible privatization of the

company.

The provision for dividends was recorded in view of the directives of clause 3 of the Companies

Authority circular no. c2-97/1 dated February 9, 1997, and the Companies Authority’s

clarification that when recording dividends, attention must be paid to all elements of the net

income before payment of bonuses to employees from earnings.

The Company’s Board of Directors believes that according to the tests in section 302 of the

Companies Law, which in the view of the legal advisers takes precedence over the contents of

the Government Companies Law and the Authority’s circulars, it is proper to determine the

amount of dividends that should be distributed in accordance with the tests in the Companies

Law only. Therefore, the aforementioned recorded appropriation does not detract from or affect

the position of the Board of Directors regarding the distribution itself.

b) Dividends on account of earnings in 2007

No dividends were calculated with respect to the year 2007, since according to the former

accounting reporting principles (Israeli Standards) the Company recorded a loss.

c) Dividends on account of earnings in 2008

The Company recorded a profit for 2008, therefore the dividend calculated according to the policy

of the Companies Authority amounts to approximately NIS 342 million and its distribution is

subject to the approval of the Board of Directors of the Company. On April 23, 2009, the

Company applied to the Director of the Companies Authority, requesting his approval to refrain

from recommending to the Board of Directors of the Company to pay a dividend for 2008. As of

the date of this report the Company did not receive his response.

For details on dividends for the previous years, see the Statement on Changes in Shareholders’

Equity in the Financial Statements.

d) Dividends on account of earnings in 2009

The Company recorded a profit for 2009. Therefore, the dividend, calculated according to the

Government Companies Authority is approximately NIS 743 million. Its division requires the

approval of the Board of Directors.

e) Profits available for distribution

The balance of profits available for distribution as of the date of this report is NIS 14,831 million.

8

1.6 Financial information regarding areas of Company activity (In millions of NIS adjusted to December 31, 2009)

For the year ended December 31, 2009

Revenues Attributed

costs

Income from Ordinary

Operations Assets

Generation 14,276 12,651 1,625 41,104

Transmission and transformation 1,685 1,149 536 16,545

Distribution 2,743 2,338 405 21,870

Total 18,704 16,138 2,566 79,519


Revenues Attributed

costs


Operations Assets

Generation 19,606 16,993 2,613 43,076


Distribution 2,825 2,429 396 20,908

Total 24,142 20,596 3,546 81,235


Revenues Attributed

costs


Operations Assets

Generation 16,391 14,571 1,820 41,409


Distribution 2,798 2,204 594 19,754

Total 20,870 17,889 2,981 77,606

Fuel costs of the Company are variable costs. All other costs are fixed short term costs.

For details of the rules and assumptions under which the division into operating segments was made,

and other details, see notes 34 and 38 to the Financial Statements.

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1.7 General environment and effect of external factors on Company activity

1.8.6 The Electricity Sector Law as Amended

Since March 5, 1996 the Company has been operating in accordance with the Electricity Sector Law

and its regulations. In addition, the Company is subject to the provisions of the Government

Companies Law and its regulations.

The Electricity Sector Law replaced the Electricity Concessions Order and pursuant to it the Company

is continuing its regular activities and provision of services, all subject to its provisions. The first

licenses for the Company’s activity in accordance with the Electricity Sector Law were received on

September 4, 1997 (see this section following and section 1.7.3 of this report).

The purpose of the Electricity Sector Law is to regulate activity in the electricity sector for the public

benefit, while ensuring reliability, availability, quality and efficiency, and creating the conditions for

competition and minimizing costs.

As stated, the Electricity Sector Law has been amended several times, among other things in order to

regulate structural changes in the electricity sector (including the future structure of the Company).

The main points of the Electricity Sector Law given below refer to its format after the introduction of

Amendment 9 of July 23, 2009.

1. The main provisions of the Electricity Sector Law regarding structural change

The rules for granting licenses by the Electricity Authority, with the approval of the Minister of

National Infrastructures ("the Minister"), pursuant to the Electricity Sector Law, include a

number of restrictions, as detailed below.

Different activities in the electricity sector will be separated, and in general, it is prohibited for

one entity to be granted a license for more than one activity (subject to exceptions described

below) and ceilings are set for generation capacity covered by generation licenses held by a

person, and for the extent of distribution covered by distribution licenses held by a person, and

also imposes other restrictions on the licenses held by a cluster of companies, particularly the

possession of licenses of different types and the generation capacity and of the distribution

permitted to be held by the cluster of companies (see sub-sections e – h below).

At the date of this report, the Company has licenses for 100% of its transmission, distribution,

supply and generation capacity. Pursuant to the Electricity Sector Order, Dates Postponement –

2009 ("Dates Postponement Order") licenses of the Company for all its operations were extended

up to January 1, 2011.

The main rules for and restrictions on granting licenses according to the Electricity Sector Law

and its amendments are as follows:

a) A license is granted for one activity, location or defined area, and different types of

generation licenses may be granted for one power station (section 4(b) of the Electricity

Sector Law).

b) The Electricity Authority, with the Minister’s approval, may grant a license for an activity

(generation, transmission, system management, distribution, supply and trade in electricity),

stipulate terms in it, and either limit or not limit its period of validity (section 4 of the

Electricity Sector law).

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c) An entity shall not be granted a license for more than one activity; however:

1) A generation license may be granted with a supply license, taking into account, inter

alia, the development of competition in the electricity sector (section No. 4 (b1) (1)). A

supply license cannot be granted to the holder of a transmission license . However, the

transitional provisions specify that a holder of a distribution license that is a

Government company or Government subsidiary may be given a supply license up to

January 1, 2012, and the Minister of Finance and the Minister of National

Infrastructures ("the Ministers") may, in consultation with the Companies Authority

and the Electricity Authority, stipulate in an Order that such supply license may be

granted up to January 1, 2013 (section 60 (d 10) of the Electricity Sector Law). A

supply license may be provided to companies possessing distribution licenses which are

not Government companies or Government subsidiaries until January 1, 2012. The

Ministers, in consultation with the Electricity Authority, are permitted to issue orders

stating that such a company may be provided a supply license until January 1 2013, and

they are permitted, after proper consultation, if they determine that such an action is

essential for the advancement of the goals of the Electricity Sector Law, to postpone -

by legal order - the aforementioned date by a period of no greater than six months

(section 60 (d 12) of the Electricity Sector Law).

2) Generation licenses may be given to the holder of a system management license or its

subsidiary, if its license so provides and this is essential to ensure reliability of

electricity supply, providing that such licenses shall not be granted for 5% or more of

the generation capacity in the market, and if the Minister determines that there are

special circumstances, for 10% or more of this capacity (section 4 (b1) (2) of the

Electricity Sector Law).

d) No generation license shall be granted to a person that, after receiving the license, shall

control 30% or more of the generation capacity in the market, and no distribution license

shall be granted to a person that, after receiving the license, shall control 25% or more of the

distribution capacity in the market (section 6 (g) (3), 6 (h) (3) of the Electricity Sector Law).

e) No generation or distribution license shall be granted to whoever controls the holder of a

transmission license (section 6 (e) of the Electricity Sector Law).

f) No transmission license shall be granted to whoever controls the holder of a generation or

distribution license (section 6 (f) of the Electricity Sector Law).

g) No generation license shall be granted to an entity that controls:

1. The holder of a distribution license for 10% or more of distribution capacity in the

market (section 6 (g) (1) of the Electricity Sector Law); or

2. The holder of a distribution license if the controlling entity, after receiving the requested

license, holds 10% or more of the generation capacity in the electricity sector (section 6

(g) (2) of the Electricity Sector Law).

h) No distribution license shall be granted to an entity that controls:

1. The holder of a generation license for 10% or more of generation capacity in the market

(section 6 (h) (1) of the Electricity Sector Law); or

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2. The holder of a generation license if the controlling entity, after receiving the requested

license, holds 10% or more of the distribution capacity in the electricity sector (section 6

(h) (2) of the Electricity Sector Law).

i) System management operations are operations requiring a license in accordance with the

Electricity Sector Law (the license is an essential service supplier's license) (section 2 of the

Electricity Sector Law).

j) No license shall be granted to a person, excluding the State, that after receiving such license

will have a system management license, or will control the holder of such a license, or will

be the holder of a distribution, generation or supply license, or will control the holder of

such licenses, except as stated in paragraph c(2) above. Accordingly, the holder of a system

management license shall be a separate corporation outside the corporate structure of the

Company. Nevertheless, at this stage, the Company can continue its system management

activity, and the license for the new corporation that will manage the system was extended

up to January 1, 2011, with an option for additional extensions in future (see additional

details of Amendment No. 8 below).

k) The Ministers, in consultation with the Electricity Authority and with the Companies

Authority, may determine different percentages from those stated in paragraphs (d), (g) and

(h) above, which specify the limitations on the granting of generation and distribution

licenses, if they believe that this is essential for promoting the aims of the Law (the different

rates may involve either an increase or a decrease in the total generation and distribution

capacity that one entity may hold or that a license holder may control through control of

other license holders, as the case may be), and also determine additional restrictions to those

specified above on the granting of licenses (section 6 (i) of the Electricity Sector Law).

l) Licenses validity – it was decided that licenses granted to the Company pursuant to the

Electricity Sector Law and that were in force before the end of the transitional period

(March 3, 2006), will remain in force for all the activities they cover until July 1, 2009. As

of the date of the report, the licenses of the Company have been extended by the "Dates

Postponement Order" up to January 1, 2011 (section 60 (d4) (2) of the Electricity Sector

Law). Licenses extended as aforementioned, will remain in force for the duration of the

extension period, provided that the Company will comply with the provisions of these

licenses, with the stipulations of the Electricity Sector Law and the stipulations of any other

law (for extension of the validity of these licenses, see paragraph (n) below.)

m) Granting substitute licenses - the Electricity Authority, with the Minister’s approval, may

grant substitute licenses to the licenses of the Company, or to some of them, during this

period. In the event that substitute licenses are granted, then licenses of the Company will

apply only to the activities for which no substitute licenses were granted (section 60 (d4) (4)

of the Electricity Sector Law).

n) Receiving generation licenses for new facilities - the Electricity Authority, with the

Minister’s approval, may grant additional generation licenses to the Company, so that the

Company may be granted new licenses within the framework of its current operations for

the power stations included in the development plan approved pursuant to section 19 of the

Electricity Sector Law up to January 1, 2009, for the period for which the Company’s

12

licenses that were granted will be in force (section 60 (d5) of the Electricity Sector Law).

o) The Electricity Authority, with the Minister’s approval, may grant generation and

distribution licenses to a Government company or Government subsidiary, with respect to

the electricity system operating in accordance with the licenses, as detailed in sections l, m,

and n above, even if this contradicts provisions that no entity shall hold licenses for

generation of 30% or more of the generation capacity in the electricity sector, and 25% or

more of the distribution capacity in the case of distribution licenses, providing that all the

following conditions are met (section 60 (d6) of the Electricity Sector Law):

1) Generation licenses will only be granted if after receiving the license, the license holder

will have power stations operating on a mixture of different types of fuel, including

diesel, natural gas and coal, but, relating to coal, it is possible that the license applicant

does not itself produce electricity from coal but has rights to obtain electricity

generated in a coal powered facility. A license holder according to this paragraph shall

be deemed to concentrate a significant portion of generation in the electricity sector and

shall be subject to the provisions of the Electricity Sector Law regarding the holder of

an essential service provider’s license, unless the Minister determines otherwise. A

decision by the Minister before January 1, 2015 requires the consent of the Minister of

Finance.

2) Distribution licenses shall be granted so that the costs of the license holders for the

electrical facilities used in their activity, at the time of granting the licenses, are as

similar as possible; however, the Ministers may, in consultation with the Electricity

Authority and the Companies Authority, determine otherwise if they believe this is

necessary to promote the purposes of the Electricity Sector Law.

3) After obtaining the license, the license holder shall not control, through another

corporation, 30% or more of generation capacity in the market, or 25% or more of the

distribution capacity.

4) The validity of the license shall be conditional on the fact that, from July 1, 2013, no

Government company or Government subsidiary, jointly or separately, shall hold more

than 51% of the means of control of the holder of a distribution or generation license,

granted pursuant to this section.

5) By January 1, 2011, the Ministers will determine, in consultation with the Electricity

Authority and with the Companies Authority, by way of an order, if any Government

company or Government subsidiary that owns the means of control of the holder of a

generation or distribution license may also own the means of control of the holder of a

transmission license (section 60 (d8) (1) of the Electricity Sector Law).

6) If the Ministers issue an order as per paragraph (1) above, stating that a Government

company or Government subsidiary may not own the means of control of the holder of

a transmission license, they will also determine the date and manner for implementing

this decision, providing that the date shall be no later than January 1, 2013 and the

validity of the transmission license will be conditional on compliance with this order

(section 60 (d8) (2) of the Electricity Sector Law).

7) If the Ministers issue an order as per paragraph (1) above, stating that a Government

13

company or Government subsidiary may own the means of control of the holder of a

transmission license, they may also, in the same order, stipulate the terms, restrictions

and provisions that will apply to such holdings, in order to promote the purposes of the

Electricity Sector Law, and the validity of the transmission license will be conditional

on compliance with this order and the provisions of the law forbidding a Government

Company or a Government subsidiary, starting from July 1, 2013, from holding more

than 51% of the means of control of the distribution or generation license holder

(section 60 (d8) (3) of the Electricity Sector Law).

p) From January 1, 2009, a Government company or Government subsidiary which holds the

means of control of a license holder pursuant to the provisions of section 60 of the

Electricity Sector Law, may not engage in the field of engineering design of power stations,

construction of power stations, logistics, information technology or the purchase of all types

of fuel. In addition, from that date onwards, a Government company or Government

subsidiary with a license as per the provisions of section 60 of the Electricity Sector Law,

may not engage in such occupations for another corporation with a license pursuant to the

Electricity Sector Law. However, if corporations have been established that may engage in

such occupations, the Ministers shall stipulate in an order that the Company may continue to

engage in these occupations until January 1, 2010, and also that notwithstanding the

provisions of the Obligation for Tenders Law – 1992 (hereinafter: “the Tenders Law”), a

Government company or Government subsidiary that holds a license pursuant to the

provisions of section 60 of the Electricity Sector Law shall give preference to these

corporations, all for the period and under the terms stipulated (section 60 (d9) of the

Electricity Sector Law). As of the report date, the process of restructuring the Company was

not implemented, therefore, the said service companies were not yet formed.

q) Extension of Dates and Licenses - The Ministers may, in consultation with the Electricity

Authority and with the Companies Authority, if they believe that this is essential to promote

the purposes of the Electricity Sector Law, may issue an order, upon approval of the

Economic Affairs Committee of the Knesset to postpone the dates in: paragraph (c)1,

(granting a supply license to a Government company or Government subsidiary that holds a

distribution license until January 1, 2012, or by approval of the Ministers up to January 1,

2013); paragraph (l) (licenses validity – licenses of all the operations were extended by the

Dates Postponement Order up to January 1, 2011); paragraph (m) (granting alternative

licenses); paragraph (n) (granting additional generation licenses to power stations included in

the development plan up to January 1, 2009) and paragraph (p) (the decision of the Ministers

up to January 1, 2011, on the possibility that a Government company or a Government

subsidiary that holds control of a holder of a generation license or a distribution license will

also hold the control means in a holder of a transmission license and implementation date

thereof) above, for additional periods of no more than one year each time. Postponement of

the dates regarding the permission to grant the Company generation licenses for new

facilities, as detailed in paragraph (n) above, will be implemented only after the Ministers

believe that there is no other reasonable alternative to the construction of a power station,

with due consideration of the urgent needs of the energy sector (section 60 (d11) of the

Electricity Sector Law). On May 13, 2009, the Company applied to the Minister of Finance

and to the Minister of National Infrastructures, requesting them to exercise their authority

14

according to the Electricity Sector Law and issue an order to extend the licenses of the

Company for all its operations, up to July 1, 2010. As at the report date, the licenses of the

Company for all its operations were extended by the Dates Postponement Order up to

January 1, 2011.

The Structure of the Company after implementing the structural change required by

the Electricity Sector Law

In the Company’s opinion, based inter alia on the policy document detailed in section 2

below, implementing the amendment to the Electricity Sector Law makes it possible to

change to a corporate structure on a gradual timetable, whereby the Company, as a parent

company, will hold subsidiaries as follows: at least four companies with generation

licenses, operating with a similar mix of fuels (subject to the remark on generation using

coal in section (o)(1) above), each of which will hold licenses for a maximum of 30% of

generation capacity in the market; at least four companies with distribution licenses, each

holding licenses for a maximum of 25% of the distribution capacity in the market, where the

costs for the electricity facilities used by each company will be as similar as possible; a

company with a transmission license, for which the Ministers will determine by January 1,

2011 whether it will remain in the framework of the Company concern; and one or more

companies to provide services (see sub-section (q) above). Until July 2013, the parent

company may hold a maximum of 51% of the means of control of the generation or

distribution companies. The system management activities are activities that require a

license in accordance with the Electricity Sector Law and will be conducted in a separate

corporation, outside the corporate structure of the Company.

It is also clarified that the interpretation given above is not the only possible interpretation

of the Electricity Sector Law, which may also be construed as stipulating a different

structure of license holding in the electricity sector, including absolute corporate separation

between the holders of licenses for the different segments of activity (subject to the

aforesaid possibility of owning means of control, pursuant to the Law).

In March 2003 the Government decided, in the framework of its plan to privatize

Government companies, to charge the Companies Authority with drawing up proposals

regarding privatization of Government companies, including the Company, after ensuring

implementation of the conclusions of the Committee for Reform in the Electricity Sector

and the decision of the Socio-Economic Cabinet on this matter, but no more than 49% of the

Company’s shares.

As of the report date, there has so far been no real progress in the structural changes, due

among other things to employee sanctions over the structural change issue and since

negotiations with various government entities on the restructuring issue did not mature into

agreements. Therefore, in the Company’s opinion, in light of the above, it is unable, at this

stage to proceed with the necessary preparations for the structural changes.

It should be noted that at the beginning of May 2009 (following sanctions of the workers'

organization over the plan for organizational change "Matzpen" (see section 3.7.4 below)),

the Management and the workers' organization agreed to open a process of discussions on

the restructuring of the electricity sector and structural change and efficiency in the

15

Company and to open negotiations on resulting workers rights, scheduled to be completed

by August 1, 2009, aiming to reach an agreement on the aforementioned changes.

It should be noted that the final decision regarding the Company’s structural change

pursuant to the provisions of the Electricity Sector Law rests with the State and is outside

the Company’s control. It is possible that further regulatory approvals may be required.

The information on implementing the organizational change in the Company is forward

looking in nature, as defined in the Securities Law. The said information is based on future

data of an uncertain realization nature, which are not under the sole control of the

Company but depend on decisions of the Government/Ministers/legislation amendments.

Moreover, this information is materially based on subjective estimates of the Company as of

the date of this report, regarding macro factors which affect the Company and the nature of

the decisions it may make in light of these developments. The said estimates may not

materialize or materialize partially or not as expected, due inter alia to changes in the

positions of the Ministers and the Government or the applicable law, which are outside the

Company's control.

2. The Policy Document

On February 15, 2007 (just before Amendment 5 to the Electricity Sector Law), the Director

General of the Ministry of National Infrastructures, the Budgets Commissioner of the Ministry of

Finance and the Director General of the Government Companies Authority, issued a document

(“the Policy Document”) containing their main recommendations for implementing the general

structural changes in the Company. On the basis of the Government stated decision and the

policy document, Amendment 5 of the Electricity Sector Law was passed on March 1, 2007 as

detailed above and below, which has been amended a number of times since Amendment 5 and

affect the organizational change, the last of which is Amendment 8.

The main points of the Policy Document:

a) Company structure

The Company will become a Government owned holding company, from which there will be a gradual split off of subsidiaries in the areas of generation, delivery, distribution and services relating to design and construction of power stations, services and logistics, information technologies and fuel. In addition, on the basis of the existing activity in the Company, a separate fully Government-owned company will be established to manage the system, manage trade and long term planning, and gradually the existing activities of the Company in these areas will be transferred to the subsidiaries, according to the planned timetable.

In the intermediate stage, Company Management and any areas of activity not incorporated separately will remain part of the holding company. One of the aims of this structural change is to make the Company more efficient by bringing more generation power into the economy at minimum cost for electricity consumers.

1) System management

A fully owned Government company will be set up to manage the system, trade and

long term planning. Each of these activities will operate as a controlled profit center.

16

Operation of the management company will be regulated. Rates to finance its activity

and its operation criteria will be determined by the Electricity Authority. The system

management company will be obliged to provide services to all parties in the Electricity

Sector, without discrimination.

2) Delivery system

A subsidiary of the Company will be set up to deal with the delivery system and to be

responsible for transmission electricity through ultra high and high voltage and for

transformation in switching stations and secondary stations. Clear rules will be

established for structural separation and independence between the company and the

delivery system company, to ensure the business independence of the delivery system

company and the development of competition. The rights to control the delivery system

company will be held by the State, to ensure independence and to prevent a conflict of

interest between the companies in the group. The operations of the delivery system

company will be regulated. The rates for the services provided by the company and its

criteria will be determined by the Electricity Authority.

3) Distribution system

The distribution segment of the Company will be split into four or five district

companies, creating territorial continuity. The companies will be as similar as possible

in their cost structures and scope of activity and will be established and will operate as

subsidiaries of the Company, in spheres of responsibility specified in the policy

document, with clear rules for structural separation and independence between the

Company and the distribution companies and among the distribution companies

themselves, to ensure the business independence of the distribution companies and

promote competition in the Electricity Sector. Operation of the distribution companies

will be regulated. The rates for the services provided by the company and its criteria

will be determined by the Electricity Authority and the distribution companies will be

obliged to provide services to all parties in the Electricity Sector, without

discrimination.

4) Supply segment

Following the incorporation of the Company’s generation companies (as detailed

below), there will be an initial assignment of all consumers in the sector to these

companies according to principles determined by the restructuring implementation

management and upon approval of the Ministers. The generation companies and

additional independent parties, other than the distribution, delivery or system

management companies, will supply electricity to consumers, according to supply

licenses. The removal of price controls in the generation and supply segments, like

consumer ability to choose, will be introduced gradually for groups of consumers,

where regulation will be removed first from the largest consumers, and from domestic

consumers at the end. Rules to ensure consumers freedom of choice will be defined up

to January 1, 2008.

17

5) Other services

The departments of design, construction and implementation of power stations,

information technology, logistics and the fuel and coal segment will be established and

operated as a separate company/ subsidiaries of the Company, with clear rules set

regarding structural separation and independence between the subsidiaries and the

Company and among the subsidiaries themselves in order to ensure the business

independence of these companies and development of competition in this sector. After

selling 49% of the Company’s holdings in the distribution and generation companies,

the Company will be permitted to establish subsidiaries that will engage in other fields

of operation. These activities will be subject to the provisions of section 6(d) of the

Electricity Sector Law.

b) Generation of electricity

1) The policy document presents two alternative structures for the generation companies:

Option 1: Generation activity in the Company’s existing generation units will be

transferred to four to six subsidiaries (“the generation companies”). These companies

will be as similar as possible in their structure, generation technologies and

consumption of fuels used to operate the generation units, and with similar generation

costs, except for the coal powered units. Each of the two existing coal sites will be

maintained by two generation companies, through joint ownership, and they will not

sell electricity directly to consumers.

Option 2: Existing generation activity will be transferred to four subsidiaries, which

will be as similar as possible in their structure, generation technologies and

consumption of fuel used to operate the generation units, excluding for the coal

powered units. Each of the two existing coal sites will be owned by one of the

generation companies, so that in addition to the other units, two of the generation

companies will each have a coal powered station. The third and fourth generation

companies will have agreements to purchase capacity and/or energy from the two

companies that own coal powered units. The purpose is to create a similar mix in the

supply of electricity.

2) Both aforementioned alternatives will include future coal powered stations (D and E)

which will be set up and incorporated by subsidiaries of the Company, subject to the

principles given in the policy document and to implement the structural change in the

Company, in line with the development plans approved by the Minister of National

Infrastructures and subject to any law.

3) The structure and the setting up of the generation companies will be determined in a

way that avoids market failures or unfair exploitation of market power in the electricity

market.

4) Clear rules will be specified for structural separation and independence between the

holding company and the generation companies, and among themselves, to ensure their

business independence and to promote competition in the electricity sector.

18

5) After the sale of 49% of the holdings of the holding company in the generation

company, the company will be permitted to engage in water desalination, subject to the

provisions of section 6(d) of the Electricity Sector Law regarding the obligation of a

essential service provider.

c) Regulation and recognition of costs

1) The regulation existing before implementation of the structural change on all segments

of the market will continue to apply, and will be removed gradually for the generation

and supply segments, as the competitive conditions in the market make it possible. The

criteria for this gradual reduction of regulation will be defined by September 1, 2007 by

the administration (see section (e) below).

2) The recognized costs of the structural change will be expressed in future electricity

rates.

3) The Electricity Authority regulation of rates of the subsidiaries and sister companies

will take into account, until it is removed (in generation and supply), a fair return on

capital.

4) At the time of the split, the Government will take steps to create the conditions required

for financial strength and stability of companies in the Company’s holdings group and

the system management company, assuming reasonable business conduct of the

regulated companies.

d) Transfer of assets and liabilities

1) The Company will transfer to the new companies the assets connected to the segments of

activity that they will handle.

2) The Company will continue to be responsible for any loans it has taken out and they will

not be transferred to the companies to be established.

3) Assets used by more than one company will be transferred to the company determined by

the Ministers, and suitable contracts will be prepared to arrange the use of these assets by

the other companies, on terms that will promote the objective of achieving competition as

soon as possible.

4) The selling price will be determined according to the book value of the assets in the

Company’s books.

5) Part of the price, equal to the balance of the Company’s loans just before the transfer,

will be paid gradually by the companies receiving the assets, on dates that will enable the

Company to pay its creditors the amounts guaranteed for the loans.

6) The balance of the proceeds will be paid to the Company immediately by the transferee

companies. Money originating from the balance of the proceeds that the Company

receives from its subsidiaries will be used by the Company immediately for investment in

the share capital of the subsidiaries.

7) The part of the proceeds that is not paid immediately will be repaid with interest to

enable the Company to pay the interest that the it owes in accordance with the conditions

of the loans taken out.

19

8) The assets will be sold to the new companies such that the assets and revenues remaining

with the Company after the structural change, directly and indirectly – through its

holdings in the new subsidiaries, will allow it to settle its debt balances to its creditors.

9) The administration that will deal with implementation of the structural change will be

responsible for dealing with the Company’s creditors on matters relating to this change.

e) Setting up an administration for the structural change

An administration will be set up to prepare all the actions, agreements, documents and

decisions necessary to implement all the principles in the policy document, in accordance

with the timetable specified therein. By the publication date of this report the aforesaid

administration had not been set up. The Director General of the Ministry of National

Infrastructures, the Budgets Commissioner and the Director General of the Government

Companies Authority will be the steering team of the administration. Each member of the

steering team is entitled to appoint a representative(s) on his behalf, who will participate in

the meetings in his place. Administration employees will be employed out of the budget of

the Government Companies Authority, subject to an unanimous employment approval of the

steering team.

An accompanying document to the policy document, dated February 15, 2007, published by

the Director General of the Government Companies Authority, the Wages Commissioner in

the Ministry of Finance, the Budgets Commissioner in the Ministry of Finance and the

Director General of the Ministry of National Infrastructures also includes recommendations

on the matter of negotiation with the employees about their rights following the structural

change, as follows:

1) A team including Company and Government representatives will conduct accelerated

negotiations with the employees’ representatives and the Histadrut in an attempt to

reach agreement on the terms for transferring employees from the Electric Corporation

to the subsidiaries/sister companies and their working conditions in these

subsidiaries/sister companies (hereinafter: “the transfer agreements”), all in accordance

with the principles specified in the policy document (hereinafter: “the structural

change”).

2) The aforesaid collective agreements will include maintaining the legal continuity of the

rights of transferred employees, including retaining their accumulated legal rights such

as pension rights.

3) Compensation to employees for the structural change, as agreed in the transfer

agreements, will be given by the relevant companies, subject to implementation of

milestones in the process of the structural change.

4) Company employees who meet the criteria will be entitled to compensation for the

decrease in the holdings of the holding company, either from the holding company or

the generation companies or distribution companies, or from the other service

companies, as applicable, according to the procedures of the Companies Authority for

compensating employees upon privatization. The employees may also compete to

purchase further holdings in these companies, on equal terms.

20

For more details of negotiations with employees on the structural change see note 24(c)

to the financial statements.

f) Timetables according to the policy document

The policy document sets out detailed timetables for implementing the structural

change. Some of them were also incorporated into Amendment 5 to the Electricity

Sector Law. Significantly all of the set dates, as specified in the policy document, have

past and Amendment 8 to the Electricity Sector Law cancelled significantly all of the

dates set by Amendment 5.

3. Letter from the Director General of the Companies Authority

On February 28, 2007, the Director General of the Companies Authority sent a letter to the

Company in which he reiterates that during implementation of the reform pursuant to the

Electricity Sector Law, including its amendment (the letter referred to Amendment 5), there will

be an examination inter alia of the implications of the structural change for the Company’s

obligations, with the aim of not preventing repayment of loans taken by the Company (“letter of

the Director General of the Companies Authority”).

4. Amendment 8 and 9 to the Electricity Sector Law

On August 5, 2008 the Knesset passed Amendment 8 (applied retroactively from July 1, 2008)

amending the Electricity Sector Law. See the main amendments to the Electricity Sector Law in

section 1.7.1 (l-o) in this report and in addition:

a. Cancellation of the milestones defined in Amendment 5 as a condition to extending the

licenses – section 60 (d7) of the Law was cancelled, which before the Amendment to the

Law regulated the extension of licenses to the Company and by force of which the

Electricity Sector Order (Dates Postponement) – 2007 and the Electricity Sector Order

(Extension of Company Licenses Validity and Implementation of the Restructuring of the

Electricity Sector) – 2007 (hereafter: "Implementation and Extension Orders") were issued.

In effect, the mechanism of the Implementation and Extension Orders, the milestones and

the schedules stipulated by law and by the orders to establish generation, distribution and

transmission companies were cancelled.

b. Extension of dates and licenses – the Ministers upon consultation with the Electricity

Authority and the Government Companies Authority, with approval of the Economic Affairs

Committee of the Knesset, will be entitled to extend the aforementioned dates in sections

60(d4)(2) and (4), 60(d5), 60(d8) and 60(d10) of the Electricity Sector Law for additional

periods that shall not exceed one year each time. Postponement of the dates regarding the

permit to grant generation licenses for new installations to the Company, as indicated in

section 60 (d5) of the Electricity Sector Law, will be allowed only after the Ministers are

convinced that there is no other reasonable alternative to build a power station, with due

consideration of the urgent needs of the Energy Sector (section 60 (d11) of the Electricity

Sector Law).

c. As a result of Amendment 8, a future extension of the licenses does not require the Knesset

to amend the legislation but grants flexibility to the Ministers, under the provisions of the

law, to extend the aforementioned dates for additional periods that shall not exceed one year

21

each time.

According to the Dates Postponement Order, the licenses for all the activities of the

Company were extended up to January 1, 2011.

Section 17a, added to the Electricity Sector Law on July 23, 2009 under Amendment 9,

grants the Electricity Authority the authority to cancel the validity of an essential service

supplier's license (after warning that license owner), upon discovery that the holder of an

essential service supplier license failed to pay all payments due from him (in accordance

with the Electricity Sector Law or the conditions of the license) to another holder of an

essential service supplier license. The Company was conscientious in making payments due

in accordance with the law to other license holders regularly, on time and as required, except

in exceptional cases or in circumstances outside the Company's control (e.g., a strike). In

addition, the Company believes that even in the event of violating the obligation to make a

payment due to another license holder according to the law, the likelihood of applying such

a severe sanction with such far-reaching implications for the electricity sector is very low.

Amendment 9 to the Electricity Sector Law also expands the term "Rates" from payments

paid by a transmission license holder to another license holder to include payments paid by

any license holder to another and also payments paid by an essential service supplier to the

consumer for electricity generation by the consumer and payments to the consumer under

the demands management arrangements pursuant to the Electricity Sector Law.

Section 17 (c1) of the Electricity Sector Law was also amended accordingly, to regulate

payments by every essential service supplier license holder (not limited to transmission

license holders as prior to the amendment) to a license holder or a consumer (not limited to

license holders as prior to this amendment), to adapt it to the aforementioned definition of

"Rates".

5. The position of the Management and the Board of Directors regarding the structural

change

Further to Amendment 5 to the Electricity Sector Law, and the decision of the Government on

February 18, 2007, the Company’s Board of Directors decided on February 22, 2007 to set up an

internal administration in the Company (“the HQ”) to implement the structural change according

to the provisions of the Electricity Sector Law. According to this decision, the Company’s

Management submitted a detailed plan for the HQ for implementation of structural change to the

Regulatory Committee of the Board of Directors, which approved the plan. The HQ has not yet

been set up and activated because of employee sanctions (for details see note 24(c) to the

Financial Statements).

Future extension of the licenses does not require amendment of the legislation by the Knesset,

but the Ministers have been enabled, under the terms provided by the Electricity Sector Law, to

extend the said dates for additional periods that shall not exceed one year each time.

Accordingly, On December 31, 2009, the Ministers extended the licenses of the Company up to

January 1, 2011 by the Dates Postponement Order.

The Company's Management and Board of Directors is of the opinion that the Electricity Sector

Law and its amendments does not deal with all of the issues raised by the expected structural

change and does not arrange, in detail, the manner of execution of the structural change. In the

22

opinion of the Company's management and Board of Directors, the Company's real restructuring

and organizational change is essential in order to be able to fulfill the duties imposed by the

Electricity Sector Law and they intend to act to the best of their abilities to promote a real

restructuring and organizational change under a realistic outline and in agreement with the

employees organization. Attention is drawn to the stipulations of the different decisions of the

Government regarding the structural change, the policy document and the letter from the Director

General of the Companies Authority. Therefore, the Company is doing all it can to work with the

relevant elements in the Government, the employees’ organization and the Histadrut in order to

reach an arrangement agreed upon, among others, with the Company’s employees. So far, there

has been no substantial progress in implementation of the structural change, due inter alia, to

employee sanctions on issues of the structural change and since negotiations with various

Government authorities did not yet reach the agreements stage. Therefore, in the Company’s

view, this is making it impossible to proceed with the necessary preparations for the structural

change at this stage.

The Company's Board of Directors and its management also believe that executing and

implementing the structural change involves dealing with issues relating to the Company’s

creditors, in view of agreements with them, to the extent that they are affected by the structural

change, subject to the provisions of the Law. As of the date of this report, the Government and

the Company had not yet completed dealing with these matters.

Representatives of the State, the Histadrt, the employees organization and the Company agreed

on March 18, 2010, to start an intensive and continued process of discussions on the subject of

the structural and organizational change and employees rights thereto. These discussions,

attended by all parties, are scheduled to take place on several days each week, aiming to reach an

agreement on the aforementioned subjects.

It is stressed that a significant element of the structural change is beyond the control of the

Company and rests with the State. Attention is drawn to the various Government decisions

concerning the structural change, see sub-paragraph 1(n) above, in the policy document and the

letter from the Director General of the Companies Authority, see paragraph 2(e) above.

6. Additional significant provisions of the Electricity Sector Law

a) A holder of a license for transmission, distribution or system management, and the holder

of one or more generation licenses who were determined by the Minister to concentrate a

material portion of electricity generation, are defined as a holder of an essential service

provider’s license. The Company was defined as an essential service supplier.

b) The Electricity Sector Law stipulates that the holder of an essential service provider’s

license:

1) Shall provide the service to the general public without discrimination, according to the

Authority’s criteria efficiently and reliably, according to the terms of its license and any

law;

2) Shall purchase electricity from a private electricity producer, and provide infrastructure

and backup services, according to the terms of its license and any law;

3) Shall provide backup services to the holder of a self generation license, at its request,

23

according to the terms of its license and any law;

4) Shall act to ensure provision of all its services throughout the license period, including

services as per the development plan approved according to the Electricity Sector Law,

while doing everything necessary to provide the aforesaid services.

The Minister, in consultation with the Electricity Authority, may demand that the

holder of an essential service provider license submit for his approval a development

plan, either complete or in parts, for the purpose of its activities pursuant to the license,

and if it fails to submit such development plan, he may, in consultation with the

Electricity Authority, determine a development plan for the license holder, and in this

case the license holder must operate accordingly. The Minister may determine

regulations regarding the responsibility of the holder of a transmission license for

development of the electricity sector, pursuant to the aforesaid development plan,

including planning the electricity network.

In addition, the Electricity Sector Law states that: the holder of an essential service

provider’s license must prepare financial statements as defined by the Ministers, in

consultation with the Minister of Justice regarding the level of detail in them, the

accounting principles for their preparation, the declarations and the notes attached to

them; the holder of an essential service license will collect payments pursuant to the

rates set by the Electricity Authority; the holder of a transmission license will make

payments to another license holder according to the rates set by the Electricity

Authority; and the Electricity Authority shall determine the criteria by which the holder

of an essential service provider’s license shall be entitled not to provide the service or

not to make the purchases as required by this Law, to stop, postpone or limit them, if

the license holder has not received payments for them according to any law or if the

terms for providing the service or making the purchase are not met.

c) Transfer, encumbrance and confiscation of the license or the assets:

1) A license or any part of it may not be transferred, encumbered or confiscated, directly

or indirectly, except with the Minister’s approval. Also, the guarantees given by the

license holder and/or money deriving from their realization may not be encumbered or

confiscated.

2) The Minister may stipulate in the license that certain of the license holder’s assets,

required in the Minister’s opinion to exercise the licensed activities, cannot be

transferred, encumbered or requisitioned, directly or indirectly, except with the

Minister’s approval.

d) A private electricity producer may sell electricity to the holder of an essential service

provider’s license, or to another, according to the license terms.

e) The Electricity Authority was set up to act pursuant to the purposes of the Electricity Sector

Law and the policy of the Government, the Minister or the policy of the Ministers in

accordance with their powers under any law in the electricity sector, and to supervise

compliance with the provisions of the Law and the licenses, and to perform other duties as

stipulated in the Electricity Sector Law and imposed by any other law.

24

f) The duties of the Electricity Authority shall include:

1) Setting rates and ways of updating them (for further details on the rate setting and the

applicable legislation see section 1.8 in this report).

2) Setting criteria for the standard, nature and quality of the service provided by the holder

of an essential service provider’s license, and setting criteria for cases where such a

license holder is not obliged to provide a service or make a purchase, and subject to the

development plan approved by the Minister, and supervising compliance with the

aforesaid criteria.

3) The Electricity Authority has the authority to define provisions regarding payments by

the holder of an essential service provider’s license to consumers for any breach of the

aforesaid criteria, and to check and decide on any consumer complaints. In addition, it

may give instructions regarding a specific deal with the holder of an essential service

provider’s license, if the case is covered in the rules issued by the Minister.

4) Granting licenses and supervising compliance with their provisions.

On the matter of decisions of the Electricity Authority arising from the above, see section

1.8 in this report.

On the matter of orders regarding rate setting, see section 1.8 in this report.

g) The Electricity Sector Law states that the Electricity Authority may grant operating licenses,

stipulate their terms, and limit or not limit their period of validity. Such licenses shall

become valid after approval by the Minister. In addition, the Law states that the Minister

may, if he considers it necessary to advance the purposes of the Law and the Government’s

policy or the policy regarding the electricity sector, instruct the Electricity Authority to grant

a license, change the terms of a license, add or remove conditions (for reasons to be

recorded, after hearing the position of the Electricity Authority on the matter and after

notifying the Government); if the Minister issues such an instruction, the Electricity

Authority shall execute this instruction within the time specified; if 21 days have passed

from the date when the Minister notified the Government and no written request to discuss

the notice is received from the Government, the Minister’s instruction shall be deemed

valid. In addition, the Law as amended states that the Electricity Authority has various

duties of reporting to the Minister. Also, if the Minister deems that the Electricity Authority

is not acting properly, and in accordance with the provisions of the Electricity Sector Law,

he has the power to dissolve it, if within a reasonable time determined by him the Authority

fails to perform its duties (in consultation with the Minister of Finance and with the

Government’s approval). Within 30 days of dissolving the Electricity Authority as aforesaid,

a new Authority shall be appointed, and until then, the existing Electricity Authority will

continue to operate.

h) No license for an essential service provider will be issued except to a company that

undertakes to engage only in the activities according to the licenses granted to it under this

Law and in associated activities. The holder of an essential service provider license may

engage in other activities, after approval by the Ministers in consultation with the Electricity

Authority, which will not affect its activities or the supervision of compliance with its

obligations under the Electricity Sector Law.

25

i) The Electricity Sector Law states that in the event that a license granted under the Law is

cancelled, suspended or altered for the reasons given in clause 8 of the Electricity Sector

Law (the policy of the Government or the Minister regarding the electricity sector, the

contribution to the level of services to the public, the benefit to consumers and competition),

the Ministers may determine rules for granting compensation to the license holder, but

according to the aforesaid rules, it is possible that the rate of compensation may be zero. As

at the date of this report, the aforesaid rules have not yet been defined.

1.8.7 The Assets Arrangement

Provisions of the Electricity Sector Law

a) Regarding certain rights and assets held by the Company before the replacement of the

Electricity Concessions Order by the Electricity Sector Law (March 5, 1996), the Electricity

Sector Law (section 62) makes the following provisions:

a) Notwithstanding the provisions of clause 46 in the Rider to the Electricity Concessions

Order (“clause 46 of the Concessions”), the obligations of the Electric Corporation and the

rights and assets that it held when the concession expired and for which it is entitled to

compensation from the State according to the aforesaid clause, will remain in the

possession of the Electric Corporation, and no compensation will be paid for them ("assets

subject to compensation") .

b) The rights and assets for which the Electric Corporation is not entitled to compensation (as

stated in paragraph (1) above) and which are used or intended for use, whether directly or

indirectly, for its operations pursuant to this Law, shall be acquired by the Company at

their value on the day such assets and rights are purchased, in accordance with the

arrangement to be signed between the State and the Electric Corporation; in this clause,

“used” “intended for use” - as determined by the Ministers ("assets in use not subject to

compensation").

c) Another group of assets, which are not subject to compensation and are not used and are

not intended to be used by the Company in its operations, is defined in clause 46 of the

concession, as not entitling the Company for compensation upon transfer to the State,

while Section 62 does not regulate the treatment of these assets. However, since the assets

are not used and not designated for any use by the Company, they are not part of the

definition of “the enterprise”, in its meaning in the aforementioned clause 46 ("unused

assets not subject to compensation").

The Law does not specify which assets will be included in paragraph a(1) above (“assets

subject to compensation”), and which under the provisions of the Electricity Sector Law

remain in the possession of the Company, and it is not required to pay the State for them

according to the Law; or in paragraph a(2) above (“assets not subject to compensation”),

for which an assets arrangement should be made. Also, the Electricity Sector Law does

not define the method for determining the value of these assets.

According to section 62 of the Electricity Sector Law, the Company will indemnify the

26

State for any payment paid by the State arising from any obligation of the Company which

was in force at the concession expiration date, resulting from the expiration or from

applying the provisions of the Electricity Sector Law regarding the assets arrangement.

In the first year following the expiry of the concession, there were no negotiations, and in

any case the parties did not reach an arrangement and the Ministers did not define which

are the assets in use not subject to compensation (assets in use or intended for use by the

Company) and/or provisions regarding the purchase of such rights and assets (hereinafter:

“the assets arrangement”).

4) Until the arrangement is carried out (as stated in paragraph (2) above), the rights and assets

for which the arrangement is to be made will remain in the possession of the Electric

Corporation, as they were when the concession expired. If the parties fail to reach such an

arrangement within one year from the expiry of the concession, the Ministers will stipulate

the terms for the purchase of the aforesaid rights and assets.

The Position of the Company on the Assets Arrangement Subject

b) The Company believes, based on the opinion of its legal advisers on the matter of the proper

interpretation of the assets arrangement, taking into account the provisions mentioned above of

the Electricity Sector Law, the rider to the Electricity Concessions Order2, by which the

2 Section 62 of the Electricity Sector Law refers to clause 46 of the concession. In its updated version,

after the amendment to the concession in 1970, and under the heading “end of the concession”, clause 46

states as follows:

“At the end of the concession, the enterprise will be transferred free of charge, with all its fixtures

and instruments and materials, to the ownership of the High Commissioner, on condition that the

High Commissioner pays suitable compensation for the fuels, mechanisms, meters and instruments,

whether located in the storeroom or are in transit to the Company or ordered by it and belonging to

the Company that paid for them. If the Company has meanwhile set up any laboratory or other

scientific institution or library and if the High Commissioner has received that institution or library

into his possession, he will pay suitable compensation for them. However, the Company will be

entitled to claim appropriate compensation for installations and enhancements under the terms stated

in clause 44(c), as if the Government had purchased the enterprise at the time when the enterprise

was transferred to the Government’s possession. The provisions of clause 44(f) of the Rider to the

Electricity Concessions Order (“clause 44(f) of the concession”) will apply, mutatis mutandis, as if

the Government had purchased the enterprise at the aforesaid time.”

In its amended version, clause 44(c) of the Electricity Concessions Order (“clause 44(c) of the

concession”) states:

“The Government will also pay the Company proper compensation for each of the facilities that

were installed and the repairs made - excluding repairs required for normal wear and tear before the

acquisition date, and all if and to the extent that all the following conditions are met:

The facility or the enhancement has not yet been written off according to the provisions of the

27

majority of the assets that were held by the Company at the time the concession expired (both

depreciable assets that were fully depreciated, and depreciable assets that were not fully

depreciated at the time the concession expired, and excluding marginal assets) the assets are

subject to compensation and therefore should not be included in the assets arrangement. In the

current situation, where implementation of the assets arrangement was not intended to have and

does not have a material effect on the Company or its financial position, although this matter is

subject to examination by a Government team appointed to determine the method of

implementing the structural change in the Company, and to the decision of the Ministers, and

therefore there is no certainty that implementation of the assets arrangement will not have such

an effect.

The Opinion of the State

c) On February 15, 2000 the Company received a letter from the Deputy Commissioner of

Budgets in the Ministry of Finance, in which he indicated that the Government team appointed

to handle this subject, had formulated a State economic and legal opinion (which was attached

to the letter to the Company) (hereinafter: “the State opinion”), the implemention of which

could have a material effect on the Company.

According to the State opinion, with reference to the provisions of clause 44(c) and clause 46

of the concession, the Company is not entitled to compensation for investments that were

returned to the Company through provisions for depreciation, Therefore, the State opinion

included the following assets in the definition of assets not subject to compensation, included in

the assets arrangement:

a) All Company assets that at the time when the concession expired had been fully

depreciated, due to the fact that the investments in them were recognized in the rate by

way of provisions for depreciation (power stations, transmission and distribution facilities,

real estate assets and other assets such as equipment, vehicles and various buildings).

b) Assets that were not fully depreciated, to the extent of what was depreciated less the

liabilities, according to a specific rate depending on the source of their funding - mainly

second rider to the concession.

Payment for the installation and the enhancement was not made out of a debt deriving from

debentures or from the principal of the loan that has not yet been repaid and that the Government

will be obliged to repay according to the provision in sub section (c).

Payment for the facility or the enhancement was not made out of share capital or by a party

interested in a connection, as defined in the rider to the concession…”

f) Section 44(f) of the concession states as follows:

“If at the time of this purchase any debenture remains unpaid, or if capital lent to the Company and

approved under clause 38 of this concession remains unpaid, the High Commissioner shall assume

all the Company’s obligations deriving there from, but he shall be entitled to benefit from the funds

available for the amortization of these obligations.”

28

power stations, transmission and distribution facilities, certain real estate and other

equipment.

c) Company assets that are not subject to depreciation - particularly intangible assets and

shares of held companies, but not cash and inventory.

The State opinion sets out criteria for categorizing the assets as stated, as well as formulae

for calculating the value of the purchase, based on the economic value of the assets and the

liabilities. The State opinion contains no data regarding the economic value of the assets

and the obligations or the method of determining it.

The cost as of March 31, 1996 of the assets that were fully depreciated as specified in

paragraph 1) above, as shown in the Company’s financial statements as of that date, was

about NIS 4.46 billion (about NIS 7 billion in the shekels of December 2009).

The net depreciated cost at March 31, 1996 in the Company’s books of the assets specified

in paragraphs 2) and 3) above is about NIS 4.5 billion (about NIS 7 billion in the shekels

of December 2009).

Note that the aforementioned data is data as of March 31, 1996, whereas the determining

date is the concession expiration date, namely March 5, 1996.

In the State's opinion, total sum of assets not subject to compensation, to be included in the

assets arrangement is NIS 7 billion.

In the Company’s opinion, the amounts indicated above should not be used to draw

conclusions about the economic value of the assets, according to which the amount that the

Company may be asked to pay is supposed to be determined, even if the position expressed

in the State opinion is accepted.

Letter of the Electricity Administration Manager

d) Soon after receiving the State opinion, the manager of the Electricity Administration in the

Ministry of National Infrastructures (hereinafter: “the manager”) wrote to the Company, on the

instructions of the Minister, instructing the Company not to respond to the letter from the

Ministry of Finance concerning the assets arrangement before the subject had been discussed in

an orderly fashion between the Ministers’ ministries, and between the Company and the

Ministry of National Infrastructures.

The Opinion of the Company

e) The Company believes, based on the opinion of its legal advisors, that an interpretation of

section 62 of the Electricity Sector Law in a way that obliges the Company to pay such amounts

or any similar amount for the purchase of assets from the State, would be contrary to the

purpose and declared aims of the Electricity Sector Law, contrary to the proper principles of

interpretation, and would adversely affect the Company’s ownership rights because of the

damage to its shareholders’ equity, the possible demand for early repayment of Company loans,

doubt about its ability to settle its liabilities and continue to function as a going concern, while

the clear intention of the legislator was that the Company would exist and perform its functions

and the tasks imposed on it by the Electricity Sector Law and in the licenses granted by virtue

thereof.

29

In addition, accepting this interpretation, and assuming that the cost of purchase should be

recognized in the electricity rate, would oblige electricity consumers to pay once again for

assets whose purchase by the Company has already been funded by consumers through the

electricity rates.

f) It should be noted that over the years the Company created a number of floating liens on all its

assets and rights. The assets arrangement could have implications for the application of the

said floating liens on those assets that will be subject to the assets arrangement.

g) The Company is of the opinion, based on the opinion of its legal advisors, that the cost to the

Company, if and to the extent that there will be any with respect to the assets arrangement or in

connection with an acquisition directive from the Ministers, needs to be recognized in the

electricity rate base, although there is no certainty of this.

h) Certain assets, which, prior to the replacement of the Electricity Concession Order by the

Electricity Sector Law, were held and which are not used, and are not intended to be used, in

the Company's operations according to the Electricity Sector Law and which, according to the

Company's position, based on the opinion of its legal advisors, are not subject to the assets

arrangement (unused assets that are not subject to compensation) and therefore should not be

transferred to the State, probably will not remain in the Company's possession. The position

presented in the Ministry of Finance's Opinion, assumed that these assets have been transferred

to the State. The Company's policy was and is to purchase assets, which are designated to be

used in the Company's operations to produce and transmit electricity. Therefore, in the

Company's opinion, if the aforesaid assets were indeed held, their number is small and their

depreciated cost in the financial statements is low. No notice was given on behalf of the

Ministers regarding this matter as of the report date.

i) On the basis of all of the above, the Company, based on the opinion it obtained, believes that

the implementation of the assets arrangement was not meant to have and does not have a

material effect on the Company or its financial position, although the matter is subject to the

determination of the Ministers' team and, therefore, there is no certainty that the

implementation of the assets arrangement will not have this effect.

The information on the effect of the assets arrangement on the Company or its financial condition is

forward looking in nature, as defined in the Securities Law. The said information is based on future

data of an uncertain realization nature, which are not under the sole control of the Company but

depend on decisions of the Government/Ministers/legislation amendments. Moreover, this

information is materially based on subjective estimates of the Company as of the date of this report,

regarding macro factors which affect the Company and the nature of the decisions it may make in

light of these developments. The said estimates may not materialize or materialize partially or not as

expected, due inter alia to changes in the positions of the Ministers and the Government or the

applicable law, which are outside the Company's control.

30

1.8.8 Licenses and regulations drawn up by virtue of the Electricity Sector Law

a) Licenses granted to the Company:

1) On September 2, 1997, the Electricity Sector Regulations (Terms and Procedures for

Granting Licenses and the Duties of License Holders), 1997 were enacted, which inter alia

stipulate the procedures and terms that a license applicant must comply with to qualify for

a license, including terms relating to shareholders’ equity, financial resources and so forth.

The regulations also stipulate that the Minister may make the grant of an essential service

provider’s license conditional on the license applicant’s organizational and legal structure,

or on receiving an undertaking to change the aforesaid structure, and may also order an

organizational and legal structure change during the period that the license is in force.

2) The Company has a license for the transmission, distribution, supply and sale of electricity

and for trading in it, called the "Gold License" as well as separate generating licenses,

granted for the each generation unit separately (“generating licenses”)3. In 2007, a new

field of operation was included in the Electricity Sector law, defined as "System

Management". The Company performs the system management function under the Gold

License, signed by the Minister of National Infrastructures on September 4, 1997, without

being granted an additional license for system management. Since the Company has a

transmission license, it is defined as an essential service provider pursuant to the

Electricity Sector Law. Also, the Minister decided, on the basis of clause 18(b) of the

Electricity Sector Law, that since the Company concentrates a significant share of

generation and distribution of the electricity sector, it is subject to the provisions of the

Electricity Sector Law that refer to an essential service provider. The Ministers extended

the Company’s licenses up to January 1, 2011 by the Dates Postponement Order. The

Company estimates that there is no certainty that, at the end of the maximum period for

extending the licenses without making the outlined structural changes stated in the

Electricity Sector Law, the Company will be granted licenses (in full or in part) or that

there will be no change to the terms of those licenses compared to the existing licenses (all

or part). On this matter see note 1(b) to the financial statements, and also section 1.7

above regarding the structural change.

b) Sanctions for operating electricity generating units without a license

The Electricity Sector Law provides for sanctions against anyone who operates electricity

generating units without a legal license, as follows:

1. Criminal sanctions - according to the provisions of the Electricity Sector Law,

performance of any activity requiring a license under the Electricity Sector Law (including

the field of electricity generation) without a license constitutes a criminal offense for

which the company may be fined. The Law also states that an executive who does not

supervise and do everything possible to prevent these offenses being committed by a

corporation or any of its employees-may be sentenced to a year’s imprisonment and a fine.

3 On April 29, 2007, the Minister of National Infrastructures signed six new generation licenses for the following units:

Eshkol, Alon Tavor, Gezer 3, Gezer 4, Hagit 2 and Tsafit.

31

2. Revoking licenses - the Electricity Sector Law states that “no person shall carry out

activity except in accordance with a license pursuant to this Law”, and also that “if a

license is granted, the license holder shall operate according to its terms”. According to the

licenses held by the Company, the Company must follow the provisions of the Electricity

Sector Law, including any Law that comes into force after the licenses are granted. A

breach of the Law is a breach of the licenses, and the Electricity Authority may revoke the

licenses if he finds that any of their terms have been breached (such as by a breach of the

Law, as stated).

On May 16, 2007, the Electricity Authority decided on the need for the deposit of

guarantees to secure compliance with the terms of permanent electricity licenses.

According to this decision, the guarantee ceiling for a license holder shall not exceed 15

million dollars. According to this decision, the Company will be requested to deposit

guarantees according to the progress of the Company's restructuring process, including

granting of licenses for the activities of the Company.

c) Provisions stipulated in the licenses granted to the Company

The generation licenses and the Gold License that were granted to the Company stipulate,

among other things, that:

1. The Gold License and the majority of the generation licenses stipulate that each activity

will be carried out as a separate profit center, and an activity may be carried out in more

than one profit center. The profit centers are as ordered by the Minister, or the Electricity

Authority, or the Manager, according to the specific formula of each license. Some of the

licenses specify that the profit centers will be as ordered by the Minister as specified in the

attachment to the license. It should be noted that there were no such attachments to those

generating licenses regarding profit centers.

2. The license holder will submit annual financial statements audited by an external auditor

separately for each district, each activity, each generating unit or power station and each

profit center, as aforesaid in section 1 above and will also submit consolidated financial

statements for its activities under each of the licenses it holds. If the holder of a generating

license has one or more licenses for additional activities, such statements will also be

submitted for those activities, as instructed by the Minister.

3. A license holder will submit a business plan to the manager or to the Electricity Authority

or the Minister (as the case may be), including pro forma financial statements audited by

the license holder’s external auditor for its activities under the license for each license

period. The license holder will update the plan and submit the updated plan to the

manager or to the Electricity Authority (as the case may be), each year. The reports will

be prepared separately for each district, each activity, each generating unit or power

station, and each profit center (for the generating licenses, as instructed by the manager or

to the Electricity Authority (as the case may be).

4. The Company will carry out the actions and the services reliably, efficiently and without

discrimination in a manner that will not affect possible fair competition.

5. The license holder may carry out the activities associated with the activities under the

license, specified in the attachment to the license. Associated activities not included in the

32

attachment must be approved in accordance with the instructions of the Electricity Sector

Law.

6. The generating licenses stipulate that each generating unit will be available to generate

electricity according to the operating and maintenance plan submitted by the Company and

approved by the manager.

7. A development plan will be submitted to the Minister.

8. The Gold License states that infrastructure and support services will be provided to other

license holders and there is a duty to purchase electricity from private producers applies

(see clause 2.1.4 in this report).

9. It is forbidden to encumber, transfer or confiscate the assets specified in the licenses

(which include most of the Company’s assets) except with the Minister’s approval (see

clause 3.1.6.1 in this report). The Gold License also states that the Minister may add to or

remove from the list of assets in the attachment, throughout the license period.

The inclusion of or reference to an asset, in the attachment, does not grant the license

holder any right to such asset and derogate his obligations with respect to that asset, in

accordance with the provisions of the Electricity Sector Law regarding the assets

arrangement (see note 1(g) to the financial statements). In the event that a third party had

any rights in an asset of the assets used for the activities of the license holder on the

license application date, the license holder will pledge to the best of its ability to prevent a

situation where realization of rights in the asset may affect performance of his obligations

according to the license.

10. There shall be no change to or reorganization of the license holder, including merger, split,

compromise, arrangement or voluntary liquidation, without the Minister’s approval.

11. The Electricity Authority may at any time revoke all or part of the license, or suspend it or

add to its terms, rules and duties or change them, if it finds that any of the license’s terms

have been breached, or that any of the restrictions on obtaining it exist, or that the license

holder no longer meets the qualifications demanded by the Electricity Sector Law and its

regulations. The generating licenses also state that the Electricity Authority is also entitled

to act as aforesaid for the reasons given in section 8 of the Electricity Sector Law (note

that certain licenses grant the said authority to the Minister and not to the Electricity

Authority. However, following Amendment 3 to the Electricity Sector Law in April 2005,

in which the authority to grant licenses and supervise compliance with their terms was

transferred to the Electricity Authority, the provisions of the licenses granted above should

be read in light of the changes in authority stated in the amendment).

12. The holder of a generating license and a Gold License will pay the license fee set by the

Ministers.

13. A license holder will not acquire and will not hold means of control over another license

holder and will not control that holder in any other way, directly or indirectly, unless

approved by the Minister of National Infrastructures. The generation licenses also state

that control over a license holder will not be transferred, directly or indirectly, unless

approved by the Minister of National Infrastructures.

33

14. If the State is obliged to make any payment for any action or omission of the generation

license holder in connection with its activities under the license, the license holder shall

compensate the State.

15. Pursuant to the terms of the licenses, the State received exemption from liability towards

the license holder and third parties as follows:

a. No approval, permit or instruction given to the license holder for the purpose of this

license or as part of it, whether given before or after the license is granted, will

impose any responsibility by the State towards the license holder or any third party

and will not provide grounds for any claim by the license holder or such third party

against the State.

b. Nothing in the powers of approval or supervision given under this license, including

the use of such powers, imposes on the State any responsibility that according to this

license is imposed on the license holder, nor does it remove or reduce such liability.

16. The regulations specified in sub-section e) below include different provisions in additions

to the provisions included in the licenses granted to the Company.

The Company does not submit audited financial statements for the profit centers as required by

most of the licenses. Nevertheless, the licenses received for the new generating units repeat the

requirement for audited reporting by profit centers. the Company is exposed to proceedings that

may be initiated against it due to its failure to conform to these requirements. In addition, the

Electricity Sector Law determines sanctions against any entity acting without a legal license.

By the publication date of this report no steps had been taken in relation to this. In the

Company’s estimation, its failure to fulfill this requirement will have no significant

implications.

As of the date of this report, except for the aforesaid, the Company's Management estimates

that it fulfills the conditions of the granted licenses.

d) Provisions of the Electricity Sector Law regarding cancellation/suspension of license

Section 8 of the Electricity Sector Law states that when the Electricity Authority is required to

decide whether to grant a license or what terms to include in it, and when the Minister is

required to give approval under sections 11-13 of the Electricity Sector Law, they should act in

accordance with the Government or the Minister’s policy regarding the electricity sector, and

consider among other things: the contribution of the license to the level of service to the public,

the good of consumers and the contribution of the license to competition in the market.

Section 9 of the Electricity Sector Law states that the Electricity Authority may at any time

revoke a license or suspend it, and with the approval of the Minister, may add terms, rules and

obligations to it, or change them, if it decides that any of the license’s terms have been

breached, that any of the restrictions on obtaining it exist, or that the license holder no longer

meets the qualifications demanded by the Electricity Sector Law. The Authority, with the

approval of the Minister, may act as aforesaid even without the above reasons, for the

considerations specified in section 8 in the Electricity Sector Law. The Electricity Authority

will give the license holder the opportunity to state its case.

34

Regulations deriving from the Electricity Sector Law

In December 2004, the Electricity Sector Regulations (Co-generation) – 2004, and the

Electricity Sector Regulations (Terms and Procedures for Granting Licenses and Obligations of

the License Holder) (Amendment) – 2004, were published, with the emphasis on a survey of

risks and required insurances, and that same month four additional regulations were signed

which were published on February 8, 2005, as follows:

1) The Electricity Sector Regulations (Co-generation) (Amendment), 2005, including an

amendment to the Electricity Sector Regulations (Co-generation), 2004 published in

December 2004.

2) The Electricity Sector Regulations (Terms and Procedures for Granting Licenses and

Duties of License Holders) (Amendment 2) – 2005, including an amendment to the

Electricity Sector Regulations (Terms and Procedures for Granting Licenses and

Obligations of the License Holder) (Amendment) – 2004 published in December 2004

(that put the emphasis on a survey of risks and the required insurances).

3) Rules of the Electricity Sector (Transactions with an Essential Service Provider)

(Amendment) – 2005, including an extension of the application of the Rules of the

Electricity Sector (Transactions with an Essential Service Provider) – 2000 to cover an

entity that received approval from the Minister or a generating license before the

Electricity Sector Regulations (Private Conventional Electricity Producer) – 2005 came

into force, or received a generating license based on such approval, and also to a producer

whose facility is operated with renewable energy. A further amendment to these

regulations was published in the Official Gazette on February 17, 2005.

4) The Electricity Sector Regulations (Private Conventional Electricity Producer), 2005. An

amendment to these regulations was published in the Official Gazette on February 17,

2005, according to which the provisions of the regulations also apply to a producer who

received a license through a tender published before the said regulations were

implemented.

All the aforesaid regulations relate differently to producers with generating units using different technologies to those of the private producer: generating units using renewable energy - power generated from the sun, wind, water and waste. Generating units using technologies of cogeneration - units simultaneously generating electrical power and usable thermal power (steam), conventional technology including stored power.

The regulations were intended to regulate transactions between a private producer and an essential service provider for the supply of electricity and the possibility of supplying electricity to end consumers while receiving infrastructure services, backup and associated services from the holder of a transmission or distribution license.

The regulations stipulate various methods for transactions with an essential service provider, as follows: the method for the sale of energy and the method for the sale of available capacity and energy.

For each of these methods a price was set according to the terms specified in the regulations. In addition, there are cases where the price is fixed by consent between the parties.

The regulations will have implications for the Company only insofar as generating facilities are

35

set up in accordance with the approvals in principle given and/or to be given to private electricity producers, and at this stage the Company cannot estimate the effect of these regulations. For additional information, see Note 2.1.4 to the report.

As at the report date, the Company is complying with all the requirements specified in these regulations, except the requirement in the generating licenses to include the State as a beneficiary in some of the construction policies for projects that are nearly complete. In new construction policies that will be agreed by the Company, this requirement will be arranged in advance.

All the aforementioned regulations were amended in August 2009, for the purpose of regulating the actions of the system manager as the party that communicates with the private producers. The Electricity Sector Regulations (Terms and Procedures for Granting a License and Obligations of the License Holder) – 1997, were also amended to reflect Amendment 3 of the Electricity Sector Law – 2005, on the manner of directing the application for a license to the Electricity Authority, in light of its authority to grant licenses, where the license becomes valid only upon the Minister's approval.

1.8.9 The Government Companies Law

1.7.4.1 According to the Government Companies Law, a Government company is defined as a

company in which more than half of the voting power at its general meetings or the right to

appoint more than half its directors is held by the State or by the State together with a

Government company or a Government subsidiary; since the State of Israel holds

approximately 99.85% of the Company’s share capital, the Company is defined as a

Government company under this Law.

1.7.4.2 The Government Companies Law states, among other things, that:

1) A decision by a Government company to sell shares that it holds in its Government

subsidiary requires the approval of the Government and the Finance Committee of the

Knesset.

2) Decisions by Government companies on the following matters require Government

approval:

(a) Changing the company’s purposes.

(b) Increasing its registered share capital.

(c) Changing the rights linked to shares.

(d) Allocating company shares or agreement to transfer shares as required by the

foundation documents - if this could lead to a material change in the balance of power

between members of the company or grant a new member 10% or more of the face

value of the share capital or voting rights in the company or right to appoint a

director.

(e) Issue of redeemable preference shares.

(f) Issue of debentures convertible to shares, and conversion into shares of debentures

issued without the right of conversion or of a loan received by the company.

(g) Changing the company from a company that is not private to a private company, or

36

vice versa.

(h) Reorganization of the company, its voluntary liquidation, compromise, arrangement

or merger with another company.

(i) Setting up a company, alone or with others, and acquiring shares in an existing

company, excluding acquisition of shares on the stock exchange by a company for

which such acquisition is part of its normal business. If the Government company

believes that any action or transaction does not require approval under this paragraph

and the Companies Authority disagrees, the said action or transaction will be

submitted to the Government for approval.

(j) A right granted by a company or an obligation that a company assumes which could

tend to restrict the Government, directly or indirectly, whether in its government

duties or in its position as a shareholder in the company, including in connection with

structural changes and privatization, promoting competition and regulating the

industry in which the company operates; on this matter, “right or obligation” -

including a right or obligation by which any action or omission of the Government,

which is not under the company’s control, will grant a third party the right to remedies

against the company.

(k) An offer of securities to the public according to a prospectus, if the Companies

Authority believes that the result of publishing the financial reports could be that the

State, as the controlling owner of the company, would bear responsibility for any

damage caused by any misleading detail in the prospectus, according to the Securities

Law, and so informs the company.

(l) An action as a shareholder in a Government subsidiary on one of the matters

described in paragraphs (a) to (j) above.

(m) An undertaking for one of the actions specified in paragraphs (a) to (k) above.

Such decisions by a Government subsidiary also require Government approval, and will be

brought before the Ministers, by means of the parent company, to obtain such approval.

3) The Minister of Finance may, on the recommendation of the Companies Authority,

determine rules for preparing the budgets and plans, for the annual budget of the Company

and implementation thereof, and use of resources available to the Company, annual

operation plans of the Company and long term plans and Company employees standard

whether for all the Government companies or for different types.

4) A Government company will operate according to the same business considerations as

usual in non Government companies, unless the Government, with the approval of the

Finance Committee of the Knesset, has stipulated other considerations for its actions. No

other considerations for its actions were stipulated to the Company as of the date of this

report. As long as the Company is a Government Company, the Government, upon

approval of the Finance Committee of the Knesset, is entitled to make other decisions for

the actions of the Company and the Company would act according to the other

considerations for its action , also after this report.

5) In addition, according to the provisions of any law, the Minister of Finance may, in

37

consultation with the Minister of Justice, and with reference to a public company - in

consultation with the Securities Authority, determine at the suggestion of the Companies

Authority rules for preparation of financial statements by a Government company which

has been defined as providing an essential service to the public, including the items to be

included in them, the accounting principles for their preparation, and the declarations and

notes to be attached to them. By force of this order, the Government Companies

Regulations (Principles for Preparing Financial Statements of the Israel Electric

Corporation Ltd.) (Temporary Order) – 2004, were enacted.

6) The decision of the Board of Directors on designation of Company's profits or distribution

(as defined in the Companies Law) is subject to the approval of the Companies Authority.

If the Companies Authority disputes this decision of the Board of Directors, the Company

will act according to the decision of the Companies Authority, as approved by the

Government. Moreover, the said regulations will not apply to a company when the

Government, upon approval of the Finance Committee of the Knesset, decides that due to a

public offering, it is obliged to not enforce this. See also section 1.5 in this report.

7) If the Companies Authority deems that the public interest so requires, it may instruct the

Government company on how to present items in its financial statements or in any other

report that the company is required to submit according to any law, providing that

instructions on this matter are not stipulated in the rules, in law or in the generally

accepted accounting principles and in the accepted rules of reporting.

8) If the Companies Authority disagrees with the manner of presenting items in the financial

statements or in any other report that the Government company is required to submit

according to any law, it may, if it deems that the public interest so requires, instruct the

company to disclose the position of the Companies Authority and describe the dispute in

its reports, to the satisfaction of the Companies Authority.

1.7.4.3 Principles of the Government Companies Authority for preparing financial statements

According to the regulations of the Government Companies Authority (Principles for

Preparing Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order) –

2004, additional disclosure obligations are applied to the Company originating from

directives issued to the Company by the Government Companies Authority, as detailed

below:

a) Directive issued on March 2, 2004 - disclosure should be provided in the Company's

financial statements regarding the operating segments for the generation, transmission and

distribution of electricity. The disclosure will include condensed balance sheets, statements

of operations and the principal details that were used in the preparation of the areas of

operation. Disclosure will also be made of the financial targets, including targets for

achievement of the normative costs determined by the Electricity Authority, and the

differences between them and the actual costs.

b) Directive issued on September 14, 2004, as follows:

1) The Company's licenses, rates, activities, its regulation and the decisions by the State and

its authorities relate to each activity of the Company separately. This is a complex

38

company with an enormous scope of activities that provides a service to the public. In

view of the short timetable for the execution of the numerous and complicated

preparations required by the beginning of 2006, the date of the end of the licenses and of

the current rate basis, disclosure is required as detailed in this directive.

The accounting estimates and the disclosure made in the financial statements concerning

the Company's operations constitute an important phase for the purpose of proper

disclosure and meeting the timetables. Providing this disclosure in the financial

statements is essential to fulfilling the duties of transparency, proper disclosure and

complying with the duties of reporting and accountability, while creating controls and

reporting mechanisms that are essential to the Board of Directors, the Company's

management, the shareholders and other users to the financial statements.

2) The disclosure will be provided based on the principles regarding the recording of the transactions concerning the various activities and will include, among others, comparative data, including, as stated below, financial statements of the various activities, details of the assumptions, the main details and the accounting principles applied in their preparation.

The calculation of the rates for the various activities will be in accordance with the

principles that have been (or will be) prescribed by the Electricity Authority regarding this issue.

3) Disclosure regarding the activities will be provided for the operations detailed in section

5 below, and will be included in all of the annual and quarterly financial statements and the budgets (annual and multi-year), that will be filed on a current basis by the Company, in accordance with the principles and the details including in the provisions of the Authority's circulars and as detailed below.

4) Starting from the financial statements for the second quarter of 2005 and thereafter, the

aforesaid disclosure will, in addition, include the following details:

a) Financial statements of generation units to which section 6(g) to the Electricity Sector Law applies.

b) Financial statements of activities at the sites: Rutenberg and Orot Rabin c) Financial statements of the transmission segment. d) Financial statements of the distribution segment according to the details of section 5

below.

5) Below are details of the activities for which the Company was required to provide the aforementioned disclosure:

a) The distribution segments: the Northern district, Haifa district, Jerusalem district, Dan

district and the Southern district - each separately. b) The generation segments: Rutenberg site, Orot Rabin site, Haifa site, Reading site,

Eshkol site, Gezer site, Hagit site, Alon Tavor site, Ramat Hovav site, Tsafit site and the other sites as one additional generation site - each separately.

c) The transmission segment.

As of the date of this report, the Company fulfills the aforesaid directives. However, the directives on the preparation of separate financial statements for each activity as detailed in section 4 and 5 above were postponed by the Government Companies Authority in a letter dated March 26, 2006, from the Director General of the Companies Authority, notifying the Company that the implementation of the preliminary milestones is deferred by at least one quarter and that the appropriate framework and timetable for implementing the directive will be

39

defined by May 2006. Until the date of signing the financial statements, there have been no further developments in the matter.

It should be noted that implementing the aforementioned directives constitutes a condition of

these Regulations for preparing adjusted financial statements.

c) Investment in the Company

For as long as the Company is a Government company, the Government will not invest in the

Company except with the approval of the Finance Committee of the Knesset.

1.7.4.4 Application of the Government Companies Law to Government subsidiaries

The provisions of the Government Companies Law state that the Law will apply to a

Government subsidiary, just as it applies to a Government company, with certain changes. In

addition, the Government Companies Law stipulates additional provisions for a Government

subsidiary, including:

The directors of Government subsidiaries on behalf of the parent company are appointed by the

board of the parent company, with the approval of the Ministers, after consultation with the

Appointments Scrutiny Committee4.

The provisions of the Government Companies Law regarding conditions of fitness, unfitness,

proper representation of both sexes, proper representation of the Arab population and special

fitness for those with connections to Government ministers, also apply to these directors. If

the Government sells shares that it held in the parent company, or if the parent company sells

shares it held in the subsidiary, all or some of the directors appointed on behalf of the parent

company will cease to hold office as directors in the Government subsidiary, if this is a

necessary outcome of the sale, from the day that the Companies Authority or the parent

company notifies the Government subsidiary of it. If the sale makes it necessary to terminate

the office of only some of the aforesaid directors, the Ministers, after consultation with the

Appointments Scrutiny Committee, will decide which directors will be dismissed.

A decision by a Government company to sell shares that it holds in its Government subsidiary

must be approved by the Government and the Finance Committee of the Knesset (except for

certain reservations concerning the sale of shares registered for trade on a stock exchange).

The Government Companies Law authorizes the board of directors of a Government company

to demand from the CEO of the Company's subsidiary for information on any matter that in the

opinion of the board, concerns the affairs of the subsidiary, and the board is also authorized to

ask the subsidiary’s external auditor and internal auditor for reports relating to it.

1.7.4.5 The Government Companies Authority

The Government Companies Law states that the Companies Authority will advise the

Government, by means of the Minister of Finance, and will advise ministers on matters relating

to the Government companies; will follow Government guidelines to deal with matters common

4 "The Appointments Scrutiny Committee" is a committee appointed by the Minister of Finance to check the fitness and

suitability of candidates for positions as directors, chairman of the board or CEO in a Government company.

40

to all the Government companies; will monitor compliance with the recommendations of the

State Comptroller relating to Government companies and assist with such compliance; will

advise and assist Government companies on managing their affairs; will continuously monitor

the activity of each of the Government companies, including achieving their goals, the course

of business, the financial situation and the compensation policies, and will report its findings to

the Ministers; will examine the reports submitted to it from Government companies and the

material on which the reports are based and will make comments on them to the company and

to the Ministers; will handle and assist in any liquidation, merger, compromise, arrangement,

reorganization and sale of shares of Government companies; will advise the Ministerial

Committee on Privatization and will handle the implementation of decisions on privatization;

will carry out any tasks imposed on it by the Government or the Ministers and any other task

assigned to it by the Government Companies Law, in relation to any Government company.

The Companies Authority may send its own representative to any meeting of the board of

directors of a Government company. The status of the Companies Authority representative in

the said meeting will be that of a director, except that he will not be included in the count of

those present necessary to constitute a legal quorum, and he will have no voting rights.

1.7.4.6 The Board of Directors

a) Chairman of the Board

The board of directors of a Government company will elect one of its members as chairman of the board. His election must be approved by the Ministers after consultation with the Appointments Scrutiny Committee, but the Government may appoint the chairman from among the members of the board of directors, if it deems this necessary, after consulting the Appointments Scrutiny Committee. The Law regulates the conditions of fitness for the chairman of the board (see sub-sections 3(a) and 3(b) below, with the reservations listed in the Law).

The chairman of the board must give the Ministers and the Companies Authority copies of the minutes of board meetings within two weeks from every meeting and, once every six months, and whenever required by the Ministers or the Companies Authority, must submit a written report of the company’s activities and the work of the board of directors. Also, the chairman of the board must submit to the Ministers and the Companies Authority the proposed annual budget, work plans and drafts of financial reports a month before they are due to be discussed, unless the Ministers, upon consulting with the Companies Authority set a shorter period.

b) Tasks of the Board of Directors

The Government Companies Law specifies the matters which the board of directors must handle, and powers that it may not delegate. Inter alia, the board must decide the general policy of the company in terms of its purposes, its financial activities, its budgets, work plans for each year and for the long term, number of employees required, approve pursuant to the recommendation of the Chief Executive Officer (“CEO”), appointments of senior officers, as they are defined in the Government Companies Law and their pay, discuss drafts of the financial statements and the comments of the auditors to these statements and approve the provision of loans and the deposit of amounts that exceed the normal course of company business.

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The board must ensure, every year, the preparation of balance sheets and profit and loss statements, including appropriation of profits, a report of resources and their uses and consolidated financial statements.

In addition, the board must also determine, subject to the rules stipulated by the Minister of Finance, at the suggestion of the Companies Authority, the method of selecting executive officials in the company, and the conditions of fitness required of them. The board of directors must determine how other company employees will be selected and their conditions of fitness, subject to any rules that may be stipulated by the Minister of Finance at the suggestion of the Companies Authority.

The board of directors may appoint from among its members permanent committees or committees for specific matters, whose decisions will constitute recommendations to the board. The board may adopt, amend or reject these recommendations and it may also delegate powers to the committee, except for the powers mentioned above that may not be delegated.

Board meetings will take place as needed, and at least once every two months, unless the Ministers, after consultation with the Companies Authority, decide on other dates, according to the nature of the company’s business. The board will hold special meetings at the request of the Ministers, the Companies Authority, or one of the directors.

The Minister of Finance may, on the recommendation of the Companies Authority, set rules for the board’s method of working and its agenda, whether for all Government companies or by type.

c) Directors on behalf of the State

A directors on behalf of the State in a Government company (in this sub-section: “director on behalf of the State” or “director”) is appointed by the Ministers after consultation with the Appointments Scrutiny Committee. The letter of appointment will be delivered to the director by the Ministers after receiving the opinion of the Appointments Scrutiny Committee, with a copy to the company via the Companies Authority. The appointment is in force from the day the letter is delivered to the company, unless it states another date.

According to the Government Companies Law, the Minister of Finance will appoint a committee to examine the fitness and suitability of candidates to serve as a director on behalf of the State, chairman of the board or CEO of a Government Company.

According to the Government Companies Law, a director on behalf of the State in a government company must be a resident of Israel who is at least 25 years old and meets one of the following conditions:

(a) He holds an academic degree in one of the following subjects: economics, business

management, law, accountancy, public administration, engineering or labor studies,

or holds another academic degree or has completed other higher education studies,

all in relation to the main area of business of the company;

(b) He has at least five years experience in one of the following, or has cumulative

experience of at least five years in two or more of the following:

1. In a senior business management position in a large corporation.

2. In a senior public office or a senior position in the public service dealing with

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economic, commercial, administrative or legal matters.

3. In a senior position in the main area of the company’s business.

A director may not be a minister, a deputy minister, a member of the Knesset, an employee of the company or someone employed in its service, excluding the CEO and the elected employee representative of Company employees. On this matter, the chairman of the board of directors will not be deemed a company employee; the Director General and employees of the Companies Authority (unless the company is in the process of dissolution or liquidation of its business), a public representative whose other business may create a conflict of interest with his position as director of the company, anyone convicted of an offense that in the opinion of the Government’s legal adviser bears dishonor or prohibits such appointment, anyone who is unfit to serve as a director according to the Companies Order or any other law, and anyone who has an economic connection to the company or to a corporation linked to the company, as defined in the Government Companies Law, or who has a personal connection to the company management or the management of a related corporation.

The number of directors from among public employees will be no greater than two thirds of the total number of directors appointed as Government representatives.

In addition, according to the Government Companies Law, directors are subject to provisions regarding their length of service, terms of service (including compensation and expenses paid to the director) and provisions regarding the expiry of their term of office and their suspension. The Government Companies Law also stipulates obligations regarding provision of information about the company to Ministers and to the Government Authority.

If the Appointments Scrutiny Committee finds that a candidate for the position of director, chairman of the board or CEO has a personal, business or political connection to any of the Government Ministers, it will not recommend his candidacy, unless it finds that he has special qualifications in the company’s areas of activity, or that there are other special considerations of fitness in addition to the required conditions of fitness according to the Government Companies Law.

If the Appointments Scrutiny Committee decides not to recommend the appointment of a candidate who meets the aforesaid conditions, the Minister may submit an objection to the decision, which will be discussed by the plenary Government. The Committee’s reasons will be put to the Government by the Government’s legal advisor or his representative. If the Government rejects the Minister’s objection, the candidate will not be appointed as director.

In addition to the provisions of the Government Companies Law, the Government's legal adviser will publish, from time to time, opinions and guidelines on issues relating to the appointment or service of directors on behalf of the State in Government companies, such as issues of conflict of interests between the director’s business and the business of the company that could render him unfit or restrict his ability to serve as a director on behalf of the State; appointments of professional state employees as directors, the duty of trust of directors in Government companies, and the participation of such directors in discussions relating to the relationship between the State and a Government company.

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d) Payment of Directors

1. Payment to Directors from the Public

According to the Government Companies Regulations (Rules for Compensation and Expenses for Directors from the Public in Government Companies) – 1994, a director of a Government company is entitled to compensation for serving as a director, to be paid by the company according to the number of board meetings or committee meetings in which he participates (according to the company rank as stated in the aforesaid regulations). The regulations stipulate other provisions on the date of payment and other conditions under which directors are paid, up to the ceiling stated in the regulations, while an annual fee may be paid to the chairman of the board, up to the ceiling stated in the regulations.

2. Payment to External Directors

Companies Regulations (Rules for Compensation and Expenses for an External Director) - 2000, were amended on March 6, 2008. Pursuant to the amendment, the Company cannot continue paying compensation to an External Director that is relative to the compensation paid to Directors who are not External Directors (equal to such a Director in practice), as the Board of Directors decided previously and has paid to External Directors up to now. Therefore, the General Meeting of the Company approved on July 7, 2008 the decision of the Board of Directors of the Company and the decision of the Audit Committee of the Company, entitling External Directors of the Company, experts and non-experts to receive annual compensation and compensation for participating in meetings, at the minimum amounts specified in the second and third addendums to these regulations, as amended from time to time, in addition to personal accountability insurance for officers, as acceptable in the Company.

e) Other provisions

According to the Government Companies Law, a director on behalf of the State will be appointed for no more than three years from when his appointment takes effect. A director who ceases to serve can be appointed again. A director will cease to serve before the end of the period of his appointment for one of these causes: resignation by submitting a letter of resignation to the Ministers; absence from four consecutive meetings or six meetings within a year, unless the Ministers decide, after consultation with the Companies Authority, that there was a justifiable reason; inability to fulfill his function and the Ministers, after consultation with the Companies Authority, have so notified the company; conviction of an offense that in the opinion of the Government’s legal adviser bears dishonor or necessitates ending his service; existence of any of the circumstances that disqualify a person from being a director; the Companies Authority, or the Ministers, after consultation with the Companies Authority, deem that he is not performing his duties appropriately and dismissed him by a notice to the Company; the Companies Authority decides that the director does not act in a manner that promotes the implementation of the privatization decision, or acts actively or by omission in a way that affects the ability of the Company to implement a certain order or requirement related to the privatization, as detailed in the Government Companies Law; A director who was appointed as a state employee or the employee of another Government company who ceases to be so will cease to serve from the day the Companies Authority notifies the company of this, but the Ministers may, after consultation with the Companies Authority, authorize his re-appointment.

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A director on behalf of the State must, despite any other law, give, on demand, to the Ministers and the Companies Authority information about company matters and his activities in that respect. If a director on behalf of the State learns of company business that apparently involves an offense against the law or integrity, he must bring the matter to the knowledge of the chairman of the board, the Ministers, the Companies Authority and the State Comptroller without delay.

The composition of the board will give proper representation to members of both sexes, and until this is achieved, Ministers will appoint, as far as possible in the specific circumstances, members of the sex that is not sufficiently represented on the board at that time.

In addition, the composition of the board will give proper representation to the Arab population, and until this is achieved, Ministers will appoint, as far as possible in the specific circumstances, members of the Arab population. In this context - “the Arab population” includes the Druze and Circassian populations.

According to the guidelines of the Attorney General (Proper Representation of Certain Sectors), published in March 2003, in cases where the Appointments Scrutiny Committee finds that insufficient attention has been given to the matter of such proper representation, it may refuse to approve an appointment or withhold an appointment, even if the candidate has the necessary qualifications. In the absence of the required proper representation, the Committee will draw the attention of the Ministers to this fact and the meeting will be held after candidates from the population that is not properly represented are proposed or after the Ministers give the Committee satisfactory reasons in writing why no candidate as aforesaid was proposed, under the circumstances.

f) Directors from among the Employees

The Government Companies Regulations (Rules for Deciding the Elected Representative of the

Company Employees as a Director) – 1977, stipulate the obligation to appoint a director from

among the employees of a Government company or Government subsidiary that employs at

least 100 people (and is not a bank) and the methods of choosing the employees’ representative

and conditions for his fitness to serve.

The Ministers appoint the directors from among the six employees who received the greatest

number of votes from the other employees. The selection method will be general, personal,

secret and direct. This director is not subject to the normal fitness conditions applying to

directors on behalf of the State.

g) The Chief Executive Officer

The CEO of a Government company is appointed by the board of directors with the approval of

the Ministers, after consultation with the Appointments Scrutiny Committee. However, the

Government may appoint the CEO if it deems this necessary. The Government Companies

Law states that the terms of fitness for a CEO of a Government company are the same as those

applying to directors on behalf of the State (see sub-section h(3)) but in exceptional cases and

on the terms stated in the Law, a person who does not meet all these conditions may be

appointed, subject to the provisions of the Government Companies Law.

The CEO is responsible for the day to day management of company affairs in the framework of

the company’s annual budget and the work plans, as decided by the board of directors, and in

45

the framework of board decisions. The CEO will have the powers that can be granted to a

business manager, in accordance with the Companies Law and the Articles of the Company

except for those powers given to the board of directors and to another authority. The General

Meeting may limit or add restrictions on the powers of the CEO, and the board may also do so.

The CEO must give the board of directors reports of the company’s day to day activities on the

dates determined for this by the board.

In certain circumstances, as specified in the Government Companies Law, the Government or

the board of directors may dismiss the CEO. The board may also suspend him, due to suspicion

of a criminal offense that has harmed the company, while observing the obligation to suspend

him if he is indicted for an offense that in the opinion of the Attorney General justifies his

suspension.

The board may appoint an acting CEO in the event that a CEO’s term of office expires or is

suspended, to serve until a permanent CEO is appointed. According to the instructions of the

Companies Authority, of July 5, 2001, the appointment of an acting CEO will take place only

under exceptional circumstances, for a limited period of time, upon approval of the Companies

Authority, where a precondition for appointment of an acting CEO is confirmation by the head

of the Companies Authority that special circumstances exist that justify this. The appointment

of an acting CEO, upon approval of the Director General of the Companies Authority, will be

for three months, and in exceptional cases for a further three months.

According to the guideline of the Companies Authority on this subject (on February 28, 2002),

the appointment of an acting CEO must also be approved by the Appointments Scrutiny

Committee, in accordance with the provisions of the Government Companies Law on

qualifications for an appointment as a CEO.

h) Holders of special office in a Government Company

1) External Auditor and Legal Adviser

The decision of the General Meeting of a Government company on the appointment of an external auditor must be approved by the Companies Authority. Also the appointment of a legal adviser for the company requires the approval of the Companies Authority.

In the Rules of Government Companies (Appointment and Pay of External Auditors) – 1994 and in the Rules of Government Companies (Appointment and Pay of Legal Advisers) – 1992, rules are set down on the manner of appointing and revoking appointments, conditions and fitness for the appointment, duration of the term in office and the pay of an external auditor or legal adviser who is not a company employee, as applicable.

The external auditor of a Government company must, notwithstanding any other law, give the board of directors, the Ministers and the Companies Authority, on demand, information on company affairs, conduct a special audit of the company, and submit a report of the results to them.

2) Internal Auditor

The Internal Audit Law – 1992 (hereinafter: “the Audit Law”) applies, inter alia, to an audited body within the meaning of section 9(5) of the State Comptroller Law – 1958. Other provisions apply by virtue of the Companies Law. According to the Audit Law, every public body will have internal audits conducted by an internal auditor. According to the

46

Government Companies Law, the board of directors of a Government Company must appoint an internal auditor, unless the Companies Authority confirms that the scope or nature of the company’s activity do not require the appointment of an internal auditor5, and the board will determine the tasks and authority of the internal auditor. The internal auditor will be subordinate to the chairman of the board of directors and the CEO, and will submit his reports and proposals to the board of directors.

1.7.4.7 Ensuring the correctness of the Financial Statements and the Board of

Directors’ Report

According to the provisions of the Government Company Regulations (Additional Report on

Actions Taken and Representations Given to Ensure the Correctness of the Financial Reports

and the Board of Directors’ Report) – 2005, a Government company and a Government

subsidiary will attach to their annual financial statements and the interim financial statements

an additional report in the format given in the Rider regarding actions taken and representations

given to ensure the correctness of the aforesaid financial reports and the board of directors’

report, including separate signed declarations from all the office holders who have signed those

reports.

If the Companies Authority considers that the public interest requires this, it may instruct the

Government company on how to present items in the financial reports or in any other report

that the company is required to submit under any law. If the Companies Authority disputes the

presentation of items in the financial reports or any other report that the company is required to

submit in accordance with any law, it may, if it considers that the public interest requires this,

instruct the company to disclose the position of the Companies Authority and to describe the

dispute in the reports to the satisfaction of the Companies Authority.

Government Companies Regulations (an Additional Report on Actions Taken and

Representations Provided to Ensure Additional Reports on the Effectiveness of the Internal

Audit of Financial Statements) – 2007, require Government Companies, including the

Company, to attach to their annual and quarterly financial statements, starting with statements

published as of December 31, 2009, an additional report on actions taken and representations

provided, to ensure adequate disclosure and correctness in the financial statements and the

report of the Board of Directors. For additional information , see paragraph o) in the report of

the Board of Directors.

1.7.4.8 Election of Senior Officers

Senior officers within the meaning of section 32(a)(4) of the Government Companies Law, in a

Government company and a Government subsidiary, are appointed according to the provisions

of the Government Company Regulations (Rules for the Election of Senior Officers) – 2005.

1.7.4.9 Rules on the Employment of Relatives

The Government Company Regulations (Rules on Employment of Relatives) – 2005 stipulate

rules and procedures regarding the employment of relatives of employees of the Government

5 The Company has an internal auditor.

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company and the Government subsidiary. The procedures for recruiting employees are subject

to these regulations and to the company’s internal rules, which are adapted to the regulations

and to the guidelines of the Company's Board of Directors. Employment of relatives in the

Company is also subject to the regulations and the internal rules and to the guidelines of the

Company's Board of Directors, which define restrictions on the employment of relatives in

positions which involve a subordinate relationship between them, or where there is a fear of

possible conflict of interest. The internal audit of all the activities of the Company also audits

the subject of employing relatives and the Company acts according to the recommendations of

its auditor. See also details of the State Comptroller's report on the subject in section 3.12.6 in

this report. In 2009, the Company assimilated 1,095 new employees. 4.7% of these employees

have relatives in the Company. The rate is decreasing continuously over the last few years.

1.7.4.10 Obtaining Information from a Government Company

3) Information for the Companies Authority

The Companies Authority may, for the purpose of performing its duties, ask the Government company and any director representing the State, plus the CEO of the company and through him, anybody working for the company or employed in its service, for any information and material on company affairs, and may study the company’s records and documents.

According to the Government Companies Regulations (Rules on Qualification of Examiner by the Authority) – 2005, if the Government Companies Authority decides to carry out an examination as part of its duties, it may authorize an examiner to study the records and documents of the Company and require the Company or the aforementioned position holders to provide information and material on the affairs of the Company. The examiner will be a suitably qualified professional, as applicable, including a lawyer, accountant, surveyor or financial adviser, depending on the terms stipulated in these regulations.

4) Information to the General Public

According to the Freedom of Information Law – 1998 (hereinafter: “Freedom of Information Law”), any Israeli citizen or resident is entitled to receive information from a public authority. Pursuant to Amendment 5 of the Freedom of Information Law of August 2, 2007, a public authority, according to the aforesaid Law, includes inter alia any Government company or Government subsidiary, excluding companies determined by the Minister of Justice, with the approval of the Constitution, Law and Justice Committee. The Amendment was applied from August 2, 2008. On November 12, 2008 Freedom of Information Directive (Government Company and Government Subsidiary which is not a public authority) – 2008, was published, excluding Government companies from the application of the Freedom of Information Law or the application of the Freedom of Information Law regarding certain fields of activity. The Company is not included in the companies that were excluded by the order, therefore, the provisions of the Freedom of Information Law apply to the Company from August 2, 2008. According to the provisions of the Freedom of Information Law, the CEO appointed an "Officer in Charge of the Freedom of Information" for the Company, who is responsible for implementing the provisions of the Freedom of Information Law in the Company. In addition, the Company is preparing for the implementation of additional instructions of the law, including the creation of a mechanism for ensuring that seekers of information receive an answer in

48

accordance with the provisions of the Law, publication of periodic reports on the implementation of the Law in the Company, gathering publications required by the Law and its regulations, etc.

According to the provisions of the Freedom of Information Law, the Company may reject a request for information and not give any information where there is a fear that the said information could harm the country’s security, foreign relations or public safety, or the security or safety of any person, relating to any information as determined by the Minister of Defense in an injunction6, information whose publication constitutes an invasion of privacy (within the meaning of the Protection of Privacy Law – 1981) and also any information whose publication is forbidden by law.

In addition, the Company may refuse to give information in certain cases, including information that could interfere with its proper functioning, information about policy in the stages of formation, or details of negotiations with an external entity or person, details of internal management of the Company that do not concern the public, information that is a commercial secret or a professional secret of information of an economical value, which if published, could materially affect its value, and the Company may also refuse to give information in other circumstances as defined in the Freedom of Information Law.

1.8.10 Decisions of the Government of Israel concerning the Electricity sector

From 1995 (towards the end of the concessions granted to the Company) and in the subsequent

years, the Government and the Socio-Economic Cabinet made various decisions concerning the

electricity sector which were largely integrated in the Electricity Sector Law. A summary of the

main decisions, as follows:

1.7.5.1 Government Decision on March 23, 2003 (No. 104)

Under the recovery plan for the Israeli economy the Government reached two decisions related to

the Company on March 23, 2003, as follows:

a. Reform the Electricity Sector, including the amendment of the Electricity Sector Law, in

accordance with the principles outlined in the decision.

b. Promote privatization of Government companies through a public offering, by requiring the

Companies Authority to compile and submit proposals for privatizing Government companies,

also relating to the Company, all after ensuring the implementation of the conclusions of the

Electricity Sector Reform Committee and decisions of the Socio-Economic Cabinet on this

subject, at a rate that will not exceed 49% of the Company's shares.

1.7.5.2 Government Decisions on September 23, 2007 (No. 2390)

Pursuant to a Government decision on September 23, 2007 and according to the policy on increasing

the generation capacity and decreasing demands in the Electricity Sector, it was decided:

a. To charge the team set up by the Minister of Finance7 on September 6, 2007, with informing

6 To the best of the Company's knowledge, at the date of signing this report, no injunctions had been issued concerning

the Company on this matter. 7 The team members were representatives of the Comptroller General, Budgets Commissioner, the legal advisor of the

Ministry of Finance, a representative of the Ministry of National Infrastructures, to be appointed by the Minister of National Infrastructures and a representative of the Electricity Authority.

49

the Ministers of the status of negotiations with the OPC company, as of that date, regarding the

tender for erecting the power station at the Mishor Rotem site. Based on the findings, the

Ministers will decide on ways to increase the electricity generation capacity for the Israeli

electricity sector in the coming years.

b. To charge the Comptroller General in the Ministry of Finance with appointing an inter-

Ministerial tenders committee, to publish an international tender for the erection of two solar

power stations in the Ashalim area.

c. To determine that Government objectives over the next few years to limit demand for

electricity during shortages should also serve to limit the demand achieved now, and instruct

the Electricity Authority to define its position on determining tools, by December 31, 2007, in

the framework of its powers in law, to enable restriction of demand for electricity during

shortages, noting Government policy.

d. To charge the Minister of National Infrastructures with utilizing his powers to promote the

Government objectives of limiting demand, inter alia, using the tools available to it by virtue of

the Electricity Sector Law – 1996, and the Energy Sources Law – 1989.

1.7.5.3 Government Decision on June 30, 2008 (No. 3704)

The Government decided on June 30, 2008, to adopt the decision of the Ministers Committee

for Socio-Economic Affairs ("The Socio-Economic Cabinet") to establish, by August 1, 2008,

two Government companies, owned by the State of Israel, to operate in the Electricity Sector, a

System Management Company Ltd. and a New Electricity Generation Stations Company Ltd.

company. To the best knowledge of the Company, two new Government companies were

registered on October 26, 2008 in the Companies Register – Systems Management Company

Ltd. and New Electricity Generation Stations Company Ltd.

It was also decided that the granting of new generation licenses to the Company will be limited

only to stations approved under the development plan, up to January 1, 2009. Pursuant to this

decision, the Electricity Sector Law was amended to enable the Electricity Authority, with

approval of the Minister of National Infrastructures to approve construction of new power

stations, under the emergency plan. See also details of the emergency plan in section 1.8.2 (a4)

herein.

The same decision of the Government also states that construction of additional power stations

by the Company beyond the aforementioned will not be approved, unless there are special

circumstances, if the Ministers, upon consultation with the Electricity Authority and the

Government Companies Authority realize that there is no reasonable alternative to the urgent

construction of a power station to ensure electricity supply to the Electricity Sector, in view of

the immediate needs of the energy sector.

1.7.5.4 Government Decision on September 18, 2008 (No. 4095)

The Government decided on September 18, 2008, to take steps to achieve more efficient energy

consumption and set a Government guideline target for reducing the expected electricity

consumption by 20% of the forecast electricity consumption in 2020, based on actual electricity

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consumption in 20068.

On January 29, 2009, the Government plenum approved the decision of the Socio-Economic

Committee on setting a guiding objective and defining tools to promote renewable energies,

especially in the Negev and Arava regions. The decision sets, inter alia, a guiding objective for

generating electricity from renewable energy at a 10% rate of the national electrical energy

requirements for 2020 (an interim objective - 5% by 2014). It was also decided to act to build

power stations based on renewable energy sources, especially in the Negev and Arava regions,

with an annual capacity of 250 megawatts at least, starting from 2010 and up to 2020. In

addition, this decision charges the Planning Manger in the Ministry of Interior, in coordination

with the Electricity Administration Manager in the Ministry of National Infrastructures, the

Ministry of Environmental Protection, Israel Lands Administration and the Ministry of Defense

to locate lands suitable for building power stations operated by renewable energies, especially

in the Negev and Arava regions and the Electricity Authority was instructed to review the

conformance of the criteria and rates to the implementation of these Government decisions.

1.7.5.5 Government Decision on May 12, 2009 (No. 129)

On May 12, 2009, the Government reached a decision on the subject of increasing competition

in the Electricity Sector. The primary principles of this decision are:

Promotion of independent electricity producers

a. Amend the Electricity Sector Law as follows:

1. To state in the law, that a condition to the validity of a critical service supplier's

license, that collects payments from electricity consumers ("Collecting Critical

Service Supplier"), is the paying of all payments required from the supplier to the

system management license holder, with respect to system management services, or

to any generation license holder, with respect to making available or generating

electricity according to the stipulations of the purchase agreement between that

Critical Service Supplier and the generation license holder.

2. Amend the rates definition in the law to include all types of payments made by a

Collecting Critical Services Supplier to the generation license holder or to the

consumer.

3. Perform the acts required to complete the regulation of independent electricity

producers through the licenses method up to August 1, 2009.

b. To charge the Minister of Finance and the Minister of National Infrastructures to

promote the actions of the Government Companies that were established by force of the

Government decision on June 30, 2008, relating to the management of the electricity

system, construction and operation of power stations in accordance with the objectives of

8 The steps include energy saving in Government facilities, financing energy saving projects in local municipalities,

assistance to energy services suppliers to obtain credit lines and preparing guidelines on the subject.

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the said companies, including recruitment of the required manpower, allocation of the

capital these companies require to implement its goals, preparation of the companies to

obtain the required licenses and promotion of their actions. To the best knowledge of the

Company, directors were appointed in these companies, however, the Company does not

have information on other actions in these companies.

c To charge the Comptroller General in the Ministry of Finance, through the Government

Procurement Administration to publish a tender for purchasing electricity for all

Government Ministries from private electricity producers. The Comptroller General will

report to the Socio-Economic Committee on the progress in implementing this item up to

June 1, 2009. To the best knowledge of the Company, no such tender was published as

yet.

d. Outline acts to locate and promote sites for establishing power stations.

Increasing the Efficiency of the Supervision over the Company

a. Establish a team to increase coordination and efficiency of the supervision over the

Company. The team is required to increase the coordination and transparency of the

actions of the entities that supervise the Company, increase efficiency of the supervision

and consulting budgets and recommendations on the method and scope of the supervision

over the Company, including establishing of a permanent coordination procedure among

team members. The team's actions will focus on material issues in the operation of the

Company, including pension, wages, actions permitted by law, all according to the

authorities of the supervising entities in Israel.

b. The Minister of Finance and the Minister of National Infrastructures will report the

initial conclusions of the team up to August 1, 2009 to the Socio-Economic Committee.

Pursuant to this decision, paragraphs (1) and (2) above were included in Amendment 9 to

the Electricity Sector Law and the Electricity Authority also made several decisions that

regulate the operation of private electricity producers, including the update of chapters E

and F of the Criteria Book on July 31, 2009, aiming to regulate the operation of the

supplier as a mediator between private electricity producers and consumers under private

transactions and to define the sphere of responsibility of the system manager (see also

Note 3 e 8 to the Financial Statements). In addition, the Government approved on July

27, 2009, a new arrangement for private electricity producers that is another step in their

integration.

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1.8 Electricity rates

1.8.1 General

The Company operates as one integrated and coordinated system to supply electricity to consumers,

from the stage of electricity generation at the generation sites, through its transmission and

transformation to distribution and supply to the end point of the individual consumer. However, in

accordance with the provisions of the Electricity Sector Law, the Electricity Authority defines

separate rates for the Company’s various activity segments. Yet, most electricity consumers pay a

single weighted rate for electricity, which covers all the segments of activity.

1. The main provisions of the Electricity Sector Law on the subject of rates are as follows:

a. The Electricity Authority will determine rates on the basis of cost, taking into account

among other things the type and standard of services. The cost will also include a fair rate

of return on capital, with due consideration of the rights and obligations of a license holder

of a Critical Service Supplier.

The law did not define a fair rate of return.

b. When setting rates, the Electricity Authority may ignore some or all of the costs that in its

opinion are not necessary to enable the holder of an essential service provider license to

fulfill its obligations.

c. Every rate will reflect the cost of the particular service with no reduction in one price at

the cost of raising another price.

d. The rates will be updated according to the update formula determined by the Electricity

Authority. The update formula will include recognized required costs, a fair rate of return

on capital, and after consultation with the Ministers, may also include an improved

efficiency factor.

2. On September 12, 2004, the Supreme Court of the High Court of Justice decided, in Case No.

7976/04 inter alia, in the matter of a petition by Company against the Electricity Authority, that

the consideration regarding maintaining the Company’s financial strength, although it is

relevant for setting the electricity rates, only reflects one aspect of the public good with which

the Electricity Authority is charged pursuant to the Electricity Sector Law. When exercising its

powers under the Law, the Electricity Authority must take account of a whole set of

considerations designed to “regulate activity in the electricity sector for the public good, while

ensuring availability, quality, efficiency, and all while creating the conditions for competition

and minimizing costs”.

3. The functions of the Electricity Authority, which was established pursuant to the Electricity

Sector Law, include setting and updating electricity rates. Decisions taken by the Electricity

Authority from time to time have defined the general principles applying to all electricity rates,

as well as special decisions for various types of rates recognized for the Company. The

decisions applying to all rates are described below, while the decisions regarding particular

rates will be described in the discussions of the relevant activity segments.

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1.8.2 Decision regarding the basis for electricity rates

a. The new electricity rate

a) On February 1, 2010, the Electricity Authority reached a decision on updating the new rate base for the generation segment for the years 2010-2014, and on updating the rate structure book relating to the demand classification groups and the consumption distribution, as well as a compensation formula with respect to the delayed update, which will apply to all electricity chain segments. This decision and the rates derived from it became valid on February 15, 2010.Under this decision, the Electricity Authority updated the rate base for the generation segment for the years 2010 – 2014, which also updated rate components, including, inter alia, capital costs,, operating costs, fuels mixture and more. The recognized costs were determined after the Electricity Authority conducted a costs control of Company costs, as recorded in its records over the years.

The main points arising from this decision, are as follows::

1. Fuels Costs The fuels mixture will be calculated every year as an average of fuel mixtures

according to a forecast of load curves related to different climates. The fuels basket will be retroactively updated every year, according to the actual demand curve and updates arising from new relevant professional information. The difference will be refunded to the consumers or to the Company with interest and linkage. In addition, starting from the new rate base, the fuel mixture will be calculated and applied on a calendar basis for that year (January – December).

The Electricity Authority defined in advance the majority of the parameters to be used to calculate the fuel mixture throughout the test period, including operation dates of generation units.

The Gas Incentive provided by the new rate base is limited to the years 2009 - 2012 and applied to new gas agreements only made and entered after the current agreements (Yam Thetis agreement in 2002 and with the Egyptian gas supplier).

2. Capital Costs The recognized capital costs are comprised of the following main components:

• Depreciation • Return on Capital: Return on equity and return on the foreign capital

a) Recognized Assets and Depreciation Assets recognized in the new rate base for the generation segment were determined

according a future outline for 2010-2014 and will be updated every year. Recognized cost with respect to generation units was determined according to the development plan that includes the list of recognized units and their dates of operation (and not according to the increase in sales as implemented in the current rate).

The generation units were divided into old and new units: • "Old" units - generation units that commenced operation before December 31,

2002. • "New" units - generation units that were operated and that will be operated after

December 31, 2002. Recognition of the costs of the "old" units

• Is mainly based on costs thereof in the Company’s books. • Crude operated units that were converted to gas, where life expectation estimate

was changed - the recognized cost was determined according to the depreciation that would have accumulated if the changed estimation was made at the conversion to gas date.

• Conversion to gas investments will be recognized from the annual update date after commencing operation with gas.

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Recognition of the costs of the "new" units Costs of the "new units are recognized according to normative parameters, e.g.,

operation dates, building duration and normative interest. In the event that commercial operation will commence before the normative date, the

cost will be recognized according to the actual commercial operation date, approved by the Electricity Authority.

The "new" generation units were divided into two classes from aspects of rate recognition: − CCGTs outside of the emergency plan (except Tsafit stage B (units 1-10)). − CCGTs defined as "emergency" + Tsafit Stage B (units 11-21).

Recognized equipment costs The recognized equipment costs of the "new" units, where construction has already

started (units 1-10) are based on costs of contracts entered into by the Company. Equipment costs of CCGTs defined as "emergency" projects and of Stage B (units 11-21) were determined in a normative manner, using data from the Gas Turbine Handbook (GTH) (average costs in the global market) adjusted to the Company.

Marine shipping costs, auxiliary equipment cost and expert services cost were determined as a percentage of the cost of the primary equipment. The percentage was based on these costs in current units.

Development and installation costs - all costs except equipment, interest incurred

during the construction and exceptional costs. Development and installation costs were determined in a normative manner. The development and installation costs of the "new" units will be recognized in a

normative manner, based on an average of historical costs of building a gas turbine, a steam addition and CCGTs, in accordance with costs audit, performed by the Electricity Authority. In the event that units under construction incur costs, that are excessive in the opinion of the Company, the Company may request the Electricity Authority to recognize these costs. .

The normative development and installation costs were divided into two groups: a. Costs of Company employees are linked to changes in the average monthly salary

of an Israeli employee do not include, at this stage, pension costs of generation A and generation B employees and pension costs with respect to free electricity, holiday gifts and bonuses for generation C employees, until a final decision is reached on the pension issue.

b. Contractors costs, linked to the index of input in residential building. Financing cost during the construction period are based on normative construction duration and normative, recognized interest rates.

Fines on Failure to Meet Timetables In accordance with the decision of the Electricity Authority, if the Company fails to

meet predetermined normative timetables for commencing operation of generation units, the recognized income of the Company will be decreased under a fines mechanism, calculated on a daily basis.

A formula for calculating fines with respect to failure to meet normative operation dates of the following "new" units which have not yet commenced operation: Haifa 3 and 4, Alon Tavor "emergency" and stage B of Eshkol "emergency", Hagit "emergency" and Ramat Hovav 8 "emergency". The penalty for each unit will be calculated according to the number of delayed operation days from the normative operation date. The fine mechanism as specified in the decision of the Electricity Authority on June 29, 2009, still applies to the three "emergency" gas turbines (Eshkol, Hagit and Ramat Hovav – unit 8).

The penalty rate for a delay in construction of a steam unit is 75% of the fine for a delay in construction of a gas turbine unit.

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Maximum fine may amount up to 25% of the unit cost. A delay that exceeds one year will be penalized by one of the following sanctions:

− Recognition of costs will stop until commercial operation begins,. − Continued recognition in a normative operation date for the fuels mixture. − Review of the recognition manner and appropriate action modes, jointly with the

Ministry of National Infrastructures. b. Financing Costs Financing costs will continue to be recognized in a normative manner, based on the

recognized operating assets and not on the basis of the actual obligations. The recognized leverage remains one third equity and two thirds foreign capital. The recognized return on foreign capital is derived from three components: The financing basket of the foreign capital will be divided into three components: The

NIS financing basket component reflecting loans raised in the local market; a hedged financing basket component derived from a new hedging mechanism and NIS at higher interest rates financing basket component reflecting loans in foreign currency for which the Company is required to initiate hedging transactions. o The NIS financing basket - for which an average real NIS interest rate will be

recognized. o The hedged financing basket - for which the following components will be

recognized: an average, real NIS interest rate, the hedging obligation spreading rate for the Company or of the Company with respect to basket differences – index and interest differences between the average foreign currency interest rate and the average, real NIS interest rate. A decrease in the hedged financing basket was defined up to its cancellation within three years. The previous hedging mechanism was cancelled, the debt to consumers was packaged and will be returned to the consumers over five years.

o NIS financing basket at higher interest for which an average, higher, real NIS interest rate will be recognized. Recognized yield rates on foreign capital linked to the CPI and to exchange rates were determined according to the Financial Statements for 2007, while using the rolling formula for 2008 (and every subsequent annual update).

Return on Equity The return on equity in the generation segment will be 7.35% (9.5% before tax) compared to 7% in the current base. Total recognized financing costs will be the multiplication of the weighted recognized yield rate (equity and foreign capital) by the recognized assets basket, from which the reserve for deferred taxes will be deducted.

The Hedging Mechanism The new rate base book for the generation segment for the years 2010-2014 states that

the hedging mechanism will be updated for all segments of the electricity chain. The main principles of the mechanism are as follows: • The hedged sum will be linked to the US$ and to the Euro at 75% and 25% rates. • Refund of interest in foreign currency in excess of the NIS interest is part of the

mechanism. • Amounts accumulated to the credit or debit of the Company will be spread up to the

end of the hedging mechanism in April 2013. However, it should be noted that in light of the expected structural changes, the Electricity Authority freezes its plan up to March 31, 2011, or up to the initiation date of the structural change process, according to the earliest.

• The efficiency in the new rate base is based on operation components only, therefore, the efficiency is not applied to the hedging component.

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3. Operating Costs Recognition of operating costs in the new rate base were determined based on past

costs (2002-2006), adjusted for an increase in sales. A 2% amortization factor is applied to these costs. No final decision was made with respect to pension costs. Once the decision is reached, this component will be updated in the recognized operating costs. The rates book includes an adjustment of pension costs to the amendment as published by the Company on December 27, 2009.

The following costs were reclassified in the rate as operating costs: − Investments in operational power stations. − Joint assets capital costs. − Spare parts inventory capital costs. − Adjustment for costs of free electricity (exceeding average household

consumption). − Fuels accompanying costs loaded to fuel prices. − Coal ash treatment, crude bottoms depreciation, electricity consumption in

Company facilities. Operational salary costs were linked to the salary of an Israeli employee position and

not to the CPI, as proposed in the hearing, or to salaries of State employees, as requested by the Company.

According to the Electricity Authority's decision, only half of the spare parts inventory capital costs will recognized as calculated by the Electricity Authority in the LC method in 2002-2006. This component is recognized under the recognized operation costs and will therefore increase each year according to the increase in sales, less a 2% amortization factor, determined by the Electricity Authority.

Updates for the Transmission and Distribution Segments

Pursuant to setting a new rate base for the generation segment, the Electricity Authority also updated some of the components for the transmission and distribution segments. Return rates on foreign capital were updated for the high voltage and low voltage transmission and distribution segments, similar to the updates in the generation segment. In addition, a new hedging mechanism was applied to these segments.

The effect of the new rate base on the financial statements of the Company As of the publication date of the financial statements, the Company is still studying

the full implications of the new rate base. The Company submitted its main initial objections to the new rate to the Electricity

Authority. See Note 3 a to the financial statements on the main implications of the new rate.

b. The Previous Electricity Rate

The decision of the Authority on the "electricity rates and criteria for the years 2002-2005 and the methods of updating them" (“the rate document”) came into effect on July 5, 2002. That decision stated that if by December 31, 2005 no new rate bases for January 1, 2006 onwards had been decided, then the decisions of the Electricity Authority would be valid until such new rate bases were defined. As of the date of this report, the Electricity Authority did not set new rates.

The electricity rate was first divided into the following segments on that date:

1. Generation.

2. Transmission.

3. High voltage distribution segment.

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4. Low voltage distribution segment.

5. Consumer costs.

The majority of the consumers pay one weighted rate for electricity, including all the

operational segments, each consumer according to the connection voltage that reflects the

parts of the system required to supply electricity to that consumer. The generation rate by

itself is also used for transactions with private producers. The transmission rate is also

used for transactions with producers for their own use. Private producers who sell

electricity to the clients pay transmission and distribution rates according to the supply

voltage to the consumer.

The rate document set the cost recognized to the Company for each of the aforementioned

segments. The recognized cost is comprised of the following main components:

1. Fuel costs.

2. Equity costs.

3. Operational costs.

Recognized fuel costs consist about 52% of the current rate, capital costs about 27% and

operational costs about 16.5%.

Details of each of the above components and additional issues related to the current rate

base are presented below:

1) Fuels Costs

The fuels costs component in the rate is determined according to approved normative fuel

quantities and approved fuel prices, based on actual fuels costs.

The approved fuels quantities were determined by an estimated mixture of the use of the various power stations (that consume various types of fuel and that each have different utilization). The estimated fuel mixture is determined annually in advance based on various data, for example, the volume of demand for electricity forecast for that year, and the expected availability of each of the power stations. The fuel mixture for 2008 was determined according to the actual demand curve, since the update for that year was implemented when this data was already known. The fuel prices are continuously updated. In addition, the Electricity Authority decided that part of the savings in fuel costs deriving from the change to use of natural gas would remain with the Company as an incentive for the years 2003 – 2006.

2) Equity Costs

Recognized equity costs are comprised of the main components as follows:

- Assets base

- Depreciation

- The rate of return on equity: The annual rate of return on equity and return on foreign

capital.

a) The Assets Base:

Equity costs were calculated on the basis of the recognized active assets of the company.

Assets under construction were excluded from the equity cost calculations.

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The assets basis for the generation segment was calculated based on data of the net active

assets during 1995-1999 and for the other segments based on average assets in 2000.

b) Depreciation:

Recognized depreciation costs were based on depreciation costs recorded in the records of

the Company. Recognized depreciation costs for the generation segment were determined

on the basis of the years 1996 – 1999 and for the other segments on the basis of 2000.

c) Return on Equity:

A ratio between equity and foreign capital of one-third and two-thirds, respectively was

determined for the purpose of calculating the recognized return on equity.

(1) Return on Equity:

The annual rate of return on equity was determined at 7% for the generation segment,

5.5% for the transmission segment and 6.2% for the low and high voltage distribution

segment.

(2) Return on Foreign Capital:

A recognized division of the foreign capital between foreign capital linked to a basket

of currencies (representing loans raised abroad) and foreign capital linked to the CPI

(representing index linked loans raised in Israel) was determined for calculating the

recognized return on foreign capital. According to the course determined for this

division over the years, the percentage of the foreign capital linked to the basket of

currencies was reduced progressively on an annual basis, from 70% in 2002 to 54% in

2006. The percentage of the foreign capital linked to the basket of currencies

continued to drop in 2007 and 2008 to 50.61% and 47.43% respectively.

The interest rates on foreign capital were determined on the basis of the prevailing

market interest rates, on a weighted basis. The annual update for 2008, determined

that interest rate on foreign capital linked to the basket of currencies will be 6.76%

and the interest rate on foreign capital linked to the CPI will be 4.70%. The 2009

annual update has not yet been set for the interest rate on foreign equity. The

Electricity Authority decided that interest rates will be updated when the new rates

base for the generation segment will become effective, according to models

determined in the new rates base.

3) Operating Costs

The recognized operating costs are based on operating costs recorded in the Company's records. Recognized operating costs of the generation segment is based on the years 1996 - 1999. The other segments are based on the Financial Statements for 2000.

4) Other Subjects

a) Amortization factors Amortization factors per kWh sold, representing the expected efficiency and

intended to reflect economies of scale at cumulative annual rates. The annual rates as of the date of this report are: 1. 2.1% on inputs of the generation segment, excluding fuel; 2. 1.3%, on inputs of the transmission and transformation segment;

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3. 2.5%, on inputs of the high-voltage distribution segment; 4. 3.7% on inputs of the low-voltage distribution segment 5. 2% on inputs of consumer costs segment.

b) Annual Update Each year, in April, the Electricity Authority is supposed to carry out an annual update of the various components of the recognized costs. The updated components, among others, include: return on foreign capital, the fuel mixture, costs of purchasing electricity from independent producers, conversion of power stations to CCGT, addition due to the network and cable laying component, compensation for delay in updates, gas incentive and more. On March 3, 2009, the update was carried out retroactively for 2008. The differences with respect to the delayed update were recorded as a regulatory asset.

On May 3, 2009, the Electricity Authority published the annual update for 2009. The update included only a small part of the rate components list which should have been updated in the annual update. Update of the majority of the components e.g. interest on foreign capital, fuel mixture component, capital sum recognized for hedging purposes and additions to capital with respect to CCGTs will be carried out once the new rate base of the generation segment comes into force, in accordance with the updated models of the new base.

The update of the fuels basket and several other components was postponed to the beginning date of the new rate base for the generation segment. On February 1, 2010, the Electricity Authority published its decision on the recognized fuels mix for 2009. This mix is expected to be retroactively updated as of April 1, 2009. The Electricity Authority also published its decision on updating the natural gas price retroactively from July 2009, pursuant to entering new gas contracts.

The Electricity Authority stated in the new rate base that an incentive for new gas contracts in the years 2009-2012 will be granted. Nevertheless, the formulas determined by the Electricity Authority did not leave any incentive for the Company in 2009.

c) Current Rate Update.

Recognized fuel rates were linked to changes in fuel prices. Foreign capital costs were linked to their weights in the basket of currencies (as determined by the Bank of Israel on May 1, 2006) and other rate components are linked to the CPI.

Therefore, electricity rates are calculated biweekly (upon the publication of the CPI and upon the publication of fuel prices). The foreign capital component, linked to the basket of currencies, is updated upon the publication of the CPI and on the annual update date. The input basket of each of the segments is recalculated at each of these dates ("Theoretical Update"). Electricity rates are actually updated when the earliest of the following events occur: (1). A change to the cost of the basket of total system inputs, minus a reduction

factor, of 5.5% in relation to the updated rate. (2) A change to the cost of the basket of total system inputs, minus a reduction

factor, of 3.5%, providing that three months have elapsed from the last update date.

(3) When six months have elapsed from the last update date. (4) Differences created between the actual update and the theoretical update are

recorded as a regulatory asset (liability) and included in the rate as of the annual update date.

d) Special Additions to the Rate Additional advanced recognition of investments On August 8, 2007, the Authority decided to give the Company an additional 5%

of the recognized cost to fund its development plans, for a number of investment

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projects. Obtaining this addition is conditional on submitting reports of the physical and financial progress of those projects and supervision of them by a supervisor acting on behalf of the Electricity Authority. The addition ended in September 2008. The accumulated addition is deducted from the assets recognized in the rates basis in the manner determined by the Electricity Authority. For further information see Note 3. c.1, to the Financial Statements.

Addition for the Emergency Plan On August 27, 2008, the Minister of National Infrastructures approved an

emergency plan for the electricity sector, that includes construction of three combined cycle gas turbines: at Ramat Hovav, Eshkol and Hagit (synchronization of the gas turbine in July 2010 and the steam addition in July 2012), in addition to two gas turbines at Ramat Hovav, that were synchronized in November 2009 and in January 2010. All in addition to the approved multi-year development plan.

On December 28, 2008, the Minister of National Infrastructures approved the construction of a fourth CCGT at Alon Tavor (stage A up to the summer of 2011 and stage B, steam addition up to the summer of 2013).

On October 30, 2008, the Electricity Authority reached a decision on financing stage A of the an emergency plan for the Electricity Sector, as approved by the Minister of National Infrastructures, Detailed in Note 3 e to the financial statements.

The main principles of the decision, as made by the Electricity Authority on October 30, 2008, are:

1) Pursuant to the accelerated development needs required by the Company and mainly the emergency plan for building generation units, as decided by the Minister of National Infrastructures, and in view of the financial condition of the Company and the uncertainty in the capital markets, the Electricity Authority sets a dedicated amount for development for the years 2009 - 2010, as follows: a) The Electricity Authority will recognize the costs for financing the development

plant in the electricity rates at an accumulated amount of NIS 2 billion. This recognition will be spread over a period of two years, starting from January 2009 and ending on January 1, 2011, or up to the end of the collection.

b) The aforementioned amount in sub-section 1.a will be managed through a dedicated account, supervised by the Electricity Authority.

Allocation of resources to the Company, for the emergency plan only, will be based on achievement of plan implementation milestones, upon approval of the Electricity Authority.

c) The Electricity Authority will include its decision in calculations for defining the rates base for the generation segment and will verify that no surplus payment is created when defining the rates for the Company.

2) Recognition of this amount is subject to fulfilling the detailed conditions, including attainment of the timetables for operation of the project, as follows: a) The Company will meet the timetables for the development plan of the generation

segment, including the emergency plan, as approved by the Minister for National Infrastructures and pursuant to the stipulations of the document for a hearing, published by the Electricity Authority.

b) The CEO of the Company will report to the plenum of the Electricity Authority once every quarter on the implementation of the general development plan, including the development plan referred to in this decision, relating to meeting timetables, costs and a budget versus execution report, in a format approved by the Electricity Authority.

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c) The Company will not transfer funds to the CPY Pension Fund, exceeding the monthly current provision, until examinations are completed and decisions are made by committees appointed to this purpose in the Company, in the Government Companies Authority and the review conducted by the Electricity Authority, all subject to the law.

d) The Company will act as soon as possible to execute efficiency steps which it announced to improve the financial condition of the Company.

On October 31, 2008, the Board of Directors of the Company approved Phase A of the emergency plan for the Electricity Sector. This approval is issued pursuant to the decision of the Electricity Authority on the aforementioned principles for financing the emergency plan. The Board of Directors of the Company approved that the Management of the Company will enter an agreement with Siemens to purchase three gas turbines and peripheral equipment. This approval comes in addition to the purchase of two gas turbines from General Electric, purchased for the Ramat Hovav site. Total expected investment for this stage of the emergency plan will amount to approximately NIS 3.6 billion and is financed as follows: Approximately NIS 0.9 billion received as customer credit through Siemens and approximately NIS 2 billion will be collected through the electricity rate, in accordance with the decision of the Electricity Authority. The balance will be financed from internal sources of the Company. The Company records this rate addition, setting off from assets under construction items. As of the balance sheet date, the Company deducted the amount of NIS 951 million from the assets under construction item. The remaining financing will come from internal sources of the Company. Pursuant to the Authority’s decision of October 30, 2008, the CEO of the Company is required to submit a quarterly report to the Electricity Authority. In addition, the Company submits current reports of projects progress. The report submitted on June 15, 2009, noted delays in operation dates. The decision of the Electricity Authority of June 29, 2009 states that in the event that the Company fails to attain the timetables stipulated in the emergency plan for commercial operation of the aforementioned power stations included in it, the Company will be penalized, as follows: a) Regarding each of the two power stations at Ramat Hovav, included in the emergency

plan for the summer of 2009, which the Company undertook to operate up to and no later than July and August 2009: (1) For each month of delay in the commercial operation compared to the scheduled

date in the emergency plan for the summer of 2009, the recognized cost will be decreased by an amount of NIS 5 million for each month of delay for the months July through December 2009 and by an amount of NIS 10 million for each month of delay for the months January through June 2010.

(2) Moreover, and without derogating the aforementioned in paragraph (a), a sum amounting to one fifth of the total dedicated amount will be deducted in the event of an additional delay in the synchronization date of each of the two aforementioned power stations beyond June 30, 2010. In the event that such a deduction will result in a debt to the consumers, the Electricity Authority will determine the mechanism and period for repaying this debt.

b) Regarding each of the three power stations (gas turbines in Eshkol, Ramat Hovav and Hagit sites) included in the emergency plan for the summer of 2010, which the Company undertook to operate up to and no later than July 2010:

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(1) For each month of delay in the commercial operation compared to the scheduled


(2) Moreover, and without derogating the aforementioned in paragraph (1), a sum

amounting to one fifth of the total dedicated amount will be deducted in the event of an additional delay in the synchronization date of each of the three aforementioned power stations beyond June 30, 2011. In the event that such a deduction will result in a debt to the consumers, the Electricity Authority will determine the mechanism and period for repaying this debt.

c) The aforementioned costs deducted by the Electricity Authority will be presented as

an expense in the statement of operation of the Company, with proper disclosure. In its letter of March 9, 2010 the Electricity Authority stated that the synchronization

date is the determining date for meeting the timetables. As of the financial statements date, the Company recorded a regulatory liability of

approximately NIS 75 million with respect to deducting the aforementioned recognized costs. The Company disputes this deduction.

5) Revenues Development

As aforesaid, costs recognized in the rate are based on the previous year: In the generation segment according to an average of the years 1996 – 1999 (depreciated and factored to the year 2000 according to the increase in sales), and the other segments are based on the year 2000. Since the average rate is determined as a cost per kWh, the Company’s revenue increases every year, according to the increase in sales. On the other hand, the revenues are amortized according to amortization coefficients.

1.8.3 Reduced Social Rates

The Electricity Sector Law states that a consumer who reached retirement age and was eligible for

income support would pay a reduced fee of 50% of the domestic rate for the first 400 kWh

consumed each month for domestic purposes only.

On July 5, 2007, the Electricity Sector Regulations (Ways of Proving Eligibility for a Reduced

Payment) – 2007 came into force, which regulate the implementation of the provisions of section

31a(a) of the Electricity Sector Law regarding reduced payment for electricity by needy population

groups. The regulations include provisions for the National Insurance Institute to prove eligibility,

form of notification of eligibility and way of transferring the information to the essential service

provider. To complete the arrangement, the Electricity Authority published a decision on July 18,

2007, in which it made changes in the criteria for implementing the provisions of section 31a of the

Electricity Sector Law regarding eligibility for reduced payments. This decision regulates the

manner of applying the reduced payment in the consumer’s electric bill, and the method by which

the costs incurred by the essential service provider due to the aforesaid reduced payment will be

recognized. On June 18, 2008, the Electricity Authority decided to include in this arrangements

secondary users at the same registered consumption site, registered in the name of the registered

consumer, who meet the conditions of entitlement to reduced rates, provided that a meter to measure

their household electricity consumptions is installed in their home.

63

The Electricity Sector Law also stated that when setting rates for all consumers, the Authority would

take into account the reduction in electricity rates paid by those eligible under the aforesaid

regulations.

As of December 31,, 2009, the Company created a NIS 147 million regulatory asset (NIS 145 million for 2008, NIS 38 million for 2007) for providing reduced payments to needy populations which are yet to be received through the electricity rate from 2009.

1.8.4 Disputes between the Company and the Electricity Authority

The Company disputes the Electricity Authority's decisions regarding the electricity rate over the

years and claims that these decisions had a significant effect on its income (see details of the "open

subjects" below).

To the best knowledge of the Company, without receiving any written notice the Electricity

Authority undertook to review the decisions it made within its decision on the new rates base for the

generation segment.

Nevertheless, and despite establishing a dedicated team for this purpose, the Electricity Authority

did not relate to these subjects in its decision on the new rates base for the generation segment.

The "open subjects" are detailed below:

Subject Electricity Authority’s Decision Company’s Position

Estimated

Financial Volume

Amortization

Coefficients

The Authority has placed amortization

coefficients starting April 2004 at the

following cumulative annual rates:

2.1% for generation, 1.3% for

transmission, 2.5% in high voltage

distribution and 3.7% for low voltage

distribution. A decision was made not

to award retroactive compensation for

previous years in which amortization

coefficients were not reduced.

Unreasonable efficiency coefficients,

applied to the Company for many years,

are unreasonable and significantly

affect its revenues.

The decrease applied by the Authority

in April 2004 was too little and too late.

The Company's request is that a 2%

amortization coefficient should be

applied to the operational component

only and also to receive retroactive

compensation for previous years, for

which the amortization coefficients

were not reduced.

NIS 11,000 million

for the years 1996-

2008. (in December

2008 prices)

Fuels basket - forced

unavailability values

The Electricity Authority uses forced

unavailability values and maintenance

days lower than those accepted

worldwide, and in some cased even

lower than the actual performance of

the Company to calculate fuel baskets

recognized in the electricity rate of the

Company.

The Company believes that

unavailability values and maintenance

days for the calculation of fuel mixtures

must be based upon long term

normative parameters, which will allow

the Company to enjoy the fruits of

efficiency in operating the system

NIS 2,800 million

for the years 2003-

2007 (in current

prices)

64


Estimated

Financial Volume

Fuels basket - Gas

Incentive

The Authority set an incentive path

for the Company in June 2002 for the

years 2003 - 2006 only.

In 2007-2009, the Electricity

Authority did not leave any gas

incentive for the Company.

In the new rate base for the generation

segment, published in February 2010,

the Electricity Authority decided to

grant a gas incentive to new gas

transactions only for the years 2009 to

2012. The formulas defined by the

Authority did not provide any gas

incentive to the Company for 2009.

The current format of the incentive

prevents the Company from benefiting

from the full potential of the incentive,

due, inter alia, to delays in gas supply

to different sites for reasons outside the

Company's control. Moreover, the

Company believes that it has achieved

significant savings thanks to its efforts

on the natural gas subject and therefore

requests to receive a permanent 20%

incentive out of the total savings

realized by use of natural gas,

continuing throughout the life span of

the units operated with natural gas and

also that the rate formula be calculated

from the day of actual activation of the

generation units because of the great

uncertainty involved in the schedule of

gas supply to the sites and the

integration of the Egyptian supplier into

the system.

Total saving for the

economy for the

years 2004-2009 is

approximately NIS

23,500 million from

which the incentive

paid to the Company

is NIS 1,078 million

(in current prices).

Fuels Basket Mix for

the year of 2007

The recognized fuel mixture was

calculated annually according to an

expected demand forecast. The

Authority rejected the Company’s

request to recalculate the recognized

fuels mixture for 2007, to include the

actual increased demand and reflect

the correct fuels mixture consumed by

the Company. In the new rate base,

the Authority decided to update the

fuels mixture retroactively every year

according to the actual demand curve.

The Authority does not intend to

apply the mechanism for the fuel

mixture in 2007.

The actual demand in 2007

significantly the original 2007 demand

prediction, used to calculate the fuels

mixture. As a result the Company

incurred a considerable loss of income

for which the Company requested to

receive coverage by recalculation of the

recognized fuel basket.

NIS 690 million in

2007 (in current

prices).

65


Estimated

Financial Volume

Fuels Basket -

postponement in

converting power

stations to natural gas

and using more

expensive fuel

Gezer Combined

Cycle A

In the annual update for 2007, the

Authority stated, as part of the basic

assumptions for the 2007 fuel mixture

calculation, that the Gezer A station

will begin operating with natural gas

in mid October 2007.

In its annual update for 2008 the

Electricity Authority did not change

this decision for setting the

recognized fuels mixture for 2008.

Since the Gezer units started operating

with gas only during 2008 and operated

on diesel up to that time, the Company

incurred losses pursuant to this

decision. Since the operation of Gezer

A CCGT with gas was delayed due to

factors outside the Company's control,

the Company requested the Authority to

recognize September 2008 in the fuels

mixture as the gas arrival date to Gezer

A CCGT.

NIS 1,200 million

for the years 2007 -

2008

(in current prices)

Fuels basket -

postponed conversion

of power stations to

natural gas and use of

more expensive fuel -

Reading Power

Station

The fuels mixture, recognized for the

2005 fuel basket, was calculated

assuming that the Reading Station will

be powered by natural gas and in May

2005.

In 2005, the power station was actually

powered by crude only, which is a more

expensive fuel, due to reasons beyond

the Company’s control. Consequently

the Company incurred additional costs

that were not covered by the electricity

rate, for which the Company requests to

receive rate coverage.

NIS 275 million for

2005

(in current prices)

Fuels Basket -

Reading Power

Station - Closed by

order of the Ministry

of Environment

The Authority denied the application

of the Company to recognize the loss

of income caused to the Company as a

result of implementing the order to

close the station.

The station was closed from March to

June 2006 by an order of the Ministry

of the Environment. From the closing

date, the Company was forced to

produce electricity at alternate stations

using a more expensive fuel mixture,

using among others, diesel operated

power stations, to avoid any disruption

in power supply to consumers.

Consequently, the Company incurred

loss of income. The Company requests

to receive rate coverage for this loss of

income.

NIS 170 million for

2006

(in current prices)

66


Estimated

Financial Volume

Loss From Collection

of the Average Rate

In 2002, the Authority set an income

which the Company is entitled to

collect from the public for the purpose

of covering its expenses..

For reasons beyond the Company's

control, stemming mainly from changes

in electricity consumption habits of the

public, influenced by the indication of

the current rates, the Company failed to

collect the full income as defined by the

Authority and therefore, did not cover

its expenses. The Company appealed to

the Authority to amend the rate

structure, while compensating for years

in which the Company did not collect

the full recognized income.

NIS 953 million for

the years 2000-2008.

(in current prices)

Exogenous Expenses In 1998, the Electricity Authority set a

mechanism for annual recognition of

exogenous expenses in the electricity

rate.

In 2005, the Electricity Authority

published a decision that canceled the

mechanism established in 1998 for

recognition of exogenous expenses

and did not recognized part of the

amounts paid during the trial period

(e.g., approximately NIS 150 million

with respect to 2004).

The Electricity Authority did not

decide as yet on a new mechanism for

recognizing future expenses (as

proposed by the professional team

acting on its behalf).

The Company submitted reports to the

Authority, on these expenses annually.

The Company requests to receive rate

coverage for the full exogenous

expenses it incurred up to the

mechanism cancellation date by the

Authority.

The Company submitted in April 2006

a proposal to the Electricity Authority

for an alternative recognition

mechanism in significant exogenous

expenses it will incur in future, that

differentiates between operational cost

and investments cost..

NIS 950 million for


(9j December 2008

prices)

67


Estimated

Financial Volume

Financing Costs In 2002, the Authority recognized in

the electricity rates cost related to

funds raising costs in Israel, based on

State bonds for 10 years with an added

margin of 0.73% and on fund raising

costs abroad, based on U.S.A., State

bonds for 10 years with an added

margin of 2.4%.

The Company raised (and is expected

to raise in future) foreign capital at

volumes amounting to billions NIS each

year. Fund raising costs in Israel and

abroad, was higher in recent years than

costs recognized by the Authority

(margin of the last funds raising in

Israel was 4.35% and 6.84% abroad),

causing loss of income to the Company.

The Company requests recognition of

all financing costs it actually incurred

with respect to funds raised during the

test period.

NIS 282 million for


Electric Consumption

in Company Facilities

The Authority rejected the Company’s

claim that power consumption at the

Company’s facilities is not included in

the rate base. The Authority claims

that cost of electricity consumed in

Company facilities is part of its

recognized operation costs and the

Company should budget these costs in

the total recognized operation costs.

The current rate calculation method,

determined by the Electricity Authority,

excludes electricity consumed by

Company facilities used for the normal

operation of the Company from

coverage in the Electricity rate, since

the required income is divided by the

total electricity consumption of the

Israeli market that includes the

electricity consumption of Company

facilities.

NIS 180 million for

the years 2002-2008

(in current prices)

68

In addition, the Electricity Authority did not yet reach a decision on several material subjects (see details

below) that caused a significant damage to the Company's income over the years.

The subjects are:


Estimated

Financial Volume

Changes in the Order

of Rate Determination

for future rate setting

In its December 2005 decision the

Electricity Authority noted that it first

intends to set a new rate for the

generation system, followed by the

distribution system and only at the

end for the transmission system.

Despite the damage caused by the

delay, the Authority did not yet reach

a decision on a compensation for the

delay,

On July 30, 2008, the Authority

published a document for a hearing on

the new rate base for the generation

segment. The hearing process is still

in process at present. The Authority

reached a decision on a new rate base

for the generation segment only (in

February 2010) but not for the other

segments. The Authority did not

compensate the Company for failure

to update the rates base for the

generation segments for the previous

years.

The Company believes that determining

the order of the segments for which the

rates are updated is important. It is

necessary to begin with segments with

an accumulated deficit of costs

coverage (distribution and

transmission).

The Company incurred a considerable

loss of income due to the prolonged

delay (over four years) in updating the

rates base.

NIS 1,500 million

for each of the years

2006 - 2008

(in December 2007

prices)

69


Estimated

Financial Volume

Expenses Due to

Pension Liabilities

The Electricity Authority did not yet

reach a decision on the subject.

The Electricity Authority established

a committee in 2004 to discuss this

issue. This committee suspended its

operations at a certain stage. In the

document for the hearing on the new

rate base for the generation segment, it

indicated that its work to review

pension costs of Company employees

was not completed as yet and that it

intends to complete the review during

the approaching period and submit it

to a public hearing so that pension

costs will be reflected in the final

decision on the new rates bases of the

generation segment.

As part of its deliberations on the

subject, the Authority requested to

receive from the Company all its

correspondence with external entities

over the years.

In its decision on the new rate base for

the generation segment, the Authority

noted that pursuant to this decision, it

intends to publish principles and

guidelines for recognizing pension

costs of Company employees from

June 1996 for a public hearing and

issue a final decision on the subject

during 2010.

Due to significant changes in

calculation rules of actuarial liabilities

beginning from 2003, as determined by

the Commissioner of the Capital

Market, Insurance and Savings of the

Ministry of Finance, the Company was

obliged to record high expenses

amounts in its statements of operation

that did not have a rate coverage since

these were not included in the rate base.

Then, upon adopting the principles of

the International Accounting Standard

19 (IAS 19), considerable amounts

were charged as actuarial losses which

were not yet amortized and which are

not recognized in the electricity rate as

well. The Company believes that rate

coverage should be granted to the full

debt, arising from spreading the

actuarial changes according to IAS 19.

NIS 2,930, million as

of December 31,

2007

70

2. Matters Relating to Each Activity Segment Separately

2.1 The Generating Segment

2.1.1 General information about the generating segment

As of December 31, 2009, the Company maintains and operates 17 power station sites (including

five sites for steam driven power stations) with installed generating capacity of 11,664 megawatts.

Each Company power station site has one or more separate units to generate electricity. On

December 31, 2009 the Company had 59 generating units, of which 20 were steam powered and 39

gas turbines (of which 14 industrial gas turbines, 16 jet gas turbines, 8 combined cycle gas turbines

and 1 industrial gas turbine for future operation in the combined cycle format).

The Company’s steam driven generating units produce electricity with steam turbines and include

carbonic units powered by coal and/or fuel oil, steam units driven by fuel oil and/or natural gas, jet

gas turbines driven by diesel only and industrial gas turbines driven by diesel and/or natural gas.

Power stations in the natural gas era retain the ability to use two fuels (except Reading power

station), and can operate with both natural gas and liquid gasoline. This is to maintain their ability

to generate electricity even when there is a shortage of natural gas or a problem with its supply.

In addition to the electricity generated at its power stations, the Company purchases small amounts

of electricity (about 0.5% of the total supplied by the Company in 2009 and 0.3% in 2008) from

private electricity producers, some of whom sell all their output to the Company, while others

generate electricity for their own use and only sell to the Company their surplus production (see

section 2.1.4.2 in this report).

2.1.1.1 Structure of the Operation Sector

As mentioned the Company's operation in this sector is generation of electricity, and as of the date

of this report, the Company generated the major share of electricity in Israel, while the balance, in

minor volumes is generated by private suppliers. See also section 2.1.4.2 herein.

2.1.1.2 Legislative and Regulatory Limitations and Special Constraints applying to the Sector

The Company estimates that its operation in the generation segment, similar to its other operation

segments is subject to regulatory limitations, e.g., regulations included in the provisions of the

Electricity Sector Law and the Government Companies Law, to constraints arising from licensing

issues and licenses and permits required by various authorities and Government ministries, e.g., The

Electricity Authority, the Companies Authority, the Ministry of National Infrastructures and the

Ministry of Environmental Protection and to structural changes and emergency and development

plans in the Electricity Sector. The Company holds generation licenses granted separately to each

generation unit. For details of these aspects in the Company's operation and the different limitations,

see sections 1.7.1 and 1.7.3 herein.

2.1.1.3 Trends and Changes in Scope of Operation and Profitability

The Company estimates that various factors my affect its operation scope and profitability in this

sector, including changes in electricity consumption rates, changes in electricity rates, changes in the

supply and/or prices of raw materials required to generate electricity and entry of competitors

(including private suppliers) to the electricity generation sector. See also sections 1.7.1, 1.7.3 and

1.7.5 herein.

71

Material changes in the scope of operations during 2009:

− Shutting down Haifa B unit with a capacity of 144 megawatts.

− Commenced operation of gas turbine unit 6 in Ramat Hovav site, 118 megawatts.

Material changes in the scope of operation anticipated during 2010:

− Commencement of operation of gas turbine unit 7 at Ramat Hovav site, 118 megawatts.

− Commencement of operation of gas turbine unit 8 at Ramat Hovav site, 250 megawatts.

− Commencement of operation of Stage A of CCGT unit 1 at Hagit site, 256 megawatts.

− Commencement of operation of Stage A of CCGT unit 2 at Eshkol site, 260 megawatts.

− Commencement of operation of Stage A of CCGT unit 4 at Haifa site, 236 megawatts.

− Commencement of operation of Stage A of CCGT unit 3 at Haifa site, 236 megawatts.

2.1.1.4 Developments in Markets of the Operating Sector or Changes in Consumer Characteristics

The Company operates as one integrated and coordinated system for supplying electricity to

customers, namely all the consumers in the State of Israel, starting from the generation of electricity

and its transmission, distribution and supply and trade of electricity. The Company also operates in

the building of the infrastructures required for those operations.

2.1.1.5 Technological Changes which may have a Material Effect on the Operating Sector

The Company generates, transmits, distributes and sells electricity to all the consumers in the State

of Israel. During 2010, the Company is expected to increase the use of natural gas until the installed

capacity of gas operated units will amount to 55% of the installed capacity at the end of 2010.

Technological Changes – Transition to the use of natural gas at the sites (subject to completing

construction of the gas delivery system by Natural Gas Lines Company):

Tsafit site From 03/2010

Ramat Hovav site From 03/2010

Alon Tavor site From 12/2010

Haifa site From 12/2010

2.1.1.6 Critical Success Factors of and Changes to the Operating Sector

The Company estimates that the business success of the generation segment depends, inter alia, on

the level of demand for electricity, gas availability from its suppliers, achievement of the timetables

of the emergency plan, costs of raw materials required to generate electricity, recognition of the total

costs required to generate electricity in the electricity rate and the ability of the generating entity to

achieve efficiency both structurally and technologically. See also sections 2.1.3 and 2.1.4 to this

report.

72

2.1.1.7 Changes in Suppliers and Raw Materials in the Operating Sector

The suppliers and raw materials for this operating sector are suppliers of coal, crude, natural gas and

diesel oil, used to generate electricity. For details of changes in suppliers and raw materials see

section 2.1.10 herein.

2.1.1.8 Barriers to Entry into the Operating Sector and Relevant Changes

The Company estimates that organizations that operate in the electricity generation segment mainly

need an initial investment of equity for building generation facilities, for concluding a banks

financing agreement and the financial strength required for their current maintenance. In addition,

the complex regulation in this sector requires an organization that wishes to generate electricity to

conform to strict quality requirements and standards. Professional knowledge, experience in

electricity generation, positive goodwill in the sector, as well as availability of land to build

electricity generation facilities are also important factors. Moreover, the uncertainty of the natural

gas supply may also consist an barrier to entry regarding electricity generation that is based on

natural gas.

2.1.1.9 Structure of Competition in this Sector and Changes to it

The electricity generation segment in Israel is currently characterized by an extremely low level of

competition, the sole competitors of the Company at present are the private electricity producers,

who, at this stage, produce an insignificant volume of electricity. In light of the structural changes

required by the provisions of the Electricity Sector Law, including incorporation of generation units

as separate subsidiaries and in light of the trend indicated by the Israeli Government and the

Electricity Authority to encourage entry of private producers to the electricity sector, the Company

is unable, at this stage, to estimate the implications of the aforementioned incorporation on future

competition. See also sections 1.7.1 and 1.7.3 herein.

2.1.2 Products and Services

General

As explained above, the Company operates as one combined and coordinated system, to supply

electricity to consumers, from the generation of electricity at production sites, through its

transmission and transformation, to its distribution and supply to the end points of each consumer.

The electricity generated in the generation sites is not sold to external parties, it is transmitted to end

users through the transmission and transformation segments and supplied through the distribution

segments.

The Company’s steam driven generating units which run on coal and natural gas, are designed to

supply the basic levels of demand for electricity. At the date of this report and in accordance with

the provisions of the current contracts, the cost of generating a kWh of electricity using natural gas

at CCGT units is the lowest of all the alternatives available to the Company followed by generation

using coal, lower efficiency gas operated units, while the most expensive means per kWh generated

are operated by fuel oil and diesel oil. As the demand curve rises, the Company operates generating

units according to the criterion of cost of fuels per kWh generated with due consideration of

operational constraints.

Therefore, the Company first operates CCGT units using natural gas and the steam driven generators

that run on coal, followed by steam generators converted to gas and then gas turbine units that run

73

on natural gas and if necessary (mainly in periods of peak demand) the generating units that run on

diesel oil - industrial gas turbines and jet gas turbines, which can be started and stopped more

quickly than steam powered units, but are more expensive to run.

Following the conversion of 4 units at the Eshkol site and their operation by burning natural gas, in

2006 the Company began to use natural gas in converted units at the Reading power station, and the

project to reduce emissions and convert two units in the Haifa power station to gas was completed.

In 2008, all generation units in the Gezer site commenced operation with natural gas (instead of fuel

oil).

In 2009, all generation units at the Hagit site commenced operation fired by natural gas (instead of

diesel).

The plan is to incorporate natural gas into the Haifa, Ramat Hovav, Alon Tavor and Tsafit power

stations in 2010. As of December 31, 2009, about 35% of the Company’s total installed generating

capacity uses natural gas.

In practice, the level of generation using gas on certain dates during 2009 reached about 40% of the

total fuel consumption.

a. Steam driven generating units

On December 31, 2009 the Company had 5 power stations with 20 steam driven generating units, and a cumulative installed generating capacity of 6,462 megawatts. These electricity generating units included 10 dual purpose units (that can run on both fuel oil and coal, and currently run on coal) with a cumulative installed generating capacity of 4,840 megawatts, 4 units operating on fuel oil with a cumulative installed generating capacity of 432 megawatts, and 6 generating units currently operating on natural gas, of which 4 units are capable of operation with either natural gas or fuel oil, with a cumulative installed generating capacity of 1,340 megawatts. Dual purpose power stations, which currently run on coal, require large investment and take a long time to set up, but when they are running on coal, the cost per kWh produced by them is low. The generators run on fuel oil were used to generate electricity for basic loads until the energy crisis in the 1970s, following which it was decided to diversify fuel use by setting up the dual purpose power stations, which can also use coal. When larger quantities of natural gas become available, more of the fuel oil generators that were converted to run on natural gas will be operated (see section 2.1.13 in this report).

Haifa B (2 x 72 MW) generating units were removed from the generation system since January 2009.

Eshkol B (2 x 75 MW) and Haifa B (2 x 72 MW) generating units were declared systems under preservation since May 2009.

b. Combined cycle generating units

On December 31, 2009 the Company had 8 combined cycle gas turbine generating units, 1 at Ramat Hovav, 3 at Hagit, 2 at Gezer, 1 at Alon Tavor and 1 at Eshkol, four of which at this stage use diesel (natural gas in future), and four burn natural gas (Eshkol, Gezer and Hagit). The total installed generating capacity of the eight combined cycle units is 2,848 megawatts. In addition, one industrial gas turbine (Tsafit) which, in future, will receive steam driven addition, will operate in the combined cycle format. The total installed generating capacity of this gas

74

turbine is 248 megawatts. The combined cycle gas turbines (“CCGT”) improve burn utilization rates considerably. The combined cycle is a combination of industrial gas turbines and steam turbines. This technology exploits the residual heat emitted from the industrial gas turbines to run an additional (steam) turbine, with no extra fuel. Instead of emitting the gases to the air, its heat is exploited for further re-use.

This action contributes both to great savings in fuel and to better preservation of the environment.

Gas turbines

On December 31, 2009 the Company had 31 gas turbine generating units of which 27 units use diesel and 4 units use natural gas, with cumulative installed generating capacity of 2,204 megawatts. Of these 31 units, 25 are located in 11 separate sites designated as gas turbine power stations, and 6 units are installed on the sites of steam driven power station. Industrial gas turbines and jet gas turbines can be set up with a relatively low investment and in a short time.

However, generating electricity with gas turbines that use diesel is more expensive than with steam driven units, and the operation of jet gas turbines is more expensive than industrial gas turbines. On the other hand, gas turbines can be started and stopped more quickly. Therefore, the Company uses its gas turbines in periods of peak demand.

When natural gas is available at sites where gas turbines are located, the Company will run the industrial gas turbines with natural gas.

Electricity generation volumes and timings are dictated by the electricity consumption of end consumers at any given moment. For seasonality of electricity consumption, see section 3.5 herein.

Details of consumption development, recorded peak demands and electricity demand trends are presented in sections 2.1.5 and 2.1.6 herein.

Details of the Company's share in electricity generation in Israel, are presented in Section 2.1.5 herein.

2.1.3 Segmentation of Revenues and Profitability

2.1.3.1 Generation Segment Rate

On February 1, 2010, the Electricity Authority reached a decision on updating the new rate base for the generation segment for the years 2010-2014, and on updating the rate structure book relating to the demand classification groups and the consumption distribution and the compensation formula for the delay in rates update, to be applied to all electricity chain segments. This decision and rates deriving from it came into force on February 15, 2010. Under this decision, the Electricity Authority updated the rate base for the generation segment for the years 2010 – 2014, updating rate components, including capital costs operating costs, fuel mixture and more. The update does not include any reference to the pension costs of Company's employees. The recognized costs were determined after the Electricity Authority conducted a costs control of Company costs, as recorded in its records over the years.

For the main points arising from the Electricity Authority decision on the new rate base for the generation segment see section 1.8 in this report.

75

As of the publication date of the Financial Statements, the Company is still studying the full implications of the new rate base.

The Company submitted its initial primary objections to the determined rate. For the main implications of the new rate base, see Note 3a(1)(c) to the Financial Statements.

2.1.3.2 Revenues

Net income in the years 2008, 2009 from sales of electricity attributed to the generating segment

(according to the assumptions described in note 38 to the financial statements) amounted to about

NIS 14,180 million for sales of 48,947 million kWh, compared to about NIS 19,592 million for sales

of 50,161 million kWh in 2009, a decrease of about NIS 5,412 million in income.

2.1.3.3 Profit from regular activities - generating segment

Profit from regular activities of the generating segment for the year 2009 amounted to about NIS

1,625 million, compared to about NIS 2,613 in 2008, a decrease of about NIS 988 million.

2.1.4 Competition

2.1.4.1 General

The Company currently generates, transmits, distributes and supplies nearly all the electricity

consumed in Israel. Regarding the declaration of the Company as a monopoly and its implications,

see section 3.1.3 of this report.

The licenses granted to the Company for its activity are valid until January 1, 2011 (subject to

Decision No. 1 of the Public Services Authority - Electricity in its meeting number 282).

Regarding the provisions of the Electricity Sector Law that stipulate restrictions on holding licenses,

see section 1.7.1 of this report.

In addition, in view of the structural changes required by the Electricity Sector Law, including the

incorporation of generating units into separate subsidiaries (see sections 1.7.1 and 1.7.3 of this

report), and also in light of the wishes of the Israeli Government and the Electricity Authority to

encourage entry of private electricity producers to the electricity sector, the Company cannot

estimate the future implications of such incorporation on competition, and on the Company’s

activity, profitability and financial situation.

2.1.4.2 Private electricity producers

a) In accordance with to the Electricity Sector Law, the Company, as an essential service supplier

is obliged to purchase electricity generated by private electricity producers, although the

Electricity Sector Law does not define a maximum quantity which the Company is obliged to

purchase. In accordance with the provisions of the Law and the terms of its license, the

Company is required to allow private electricity producers to use its transmission and supply

system to provide a backup supply source to customers of the private electricity producers (the

Electricity Authority has not yet defined the backup rate).

b) The integration of private producers in the electricity sector was stipulated by the policy of the

Government of Israel and its decisions to open the electricity generating industry to private

producers. Regarding Government decisions that set targets to increase the installed electricity

76

generating capacity of private producers to 20% of the country’s installed generating capacity,

see note 1(e) to the Financial Statements.

The Government reached additional decisions on promoting private electricity producers

(decision on May 12, 2009), as included in the proposed Arrangements Law 2009-2010

"Perform the acts required to complete the regulation of independent electricity producers

through the licenses method up to August 1, 2009". The Arrangements Law also proposes to

state that a condition for the validity of the license of an essential service supplier that collects

payments from electricity consumers, is the making of all payments required from the essential

service supplier to another license holder.

c) In October 2005 the Electricity Authority determined criteria for infrastructure arrangements by

which producers can sell electricity to the Company and “supply” electricity to end consumers

using the Company’s transmission grid. For transmitting the energy, the Company will charge

a rate set by the Authority. So far, the implementation of these infrastructure arrangements are

being tested in association with IPP Ashkelon. On July 31, 2009, the Electricity Authority

published a document for a hearing on updating chapters E - F to the criteria, that include

extensions, additions and updates of the criteria published since 2005. The updated criteria

specify the relations and work procedures between the system manager and the suppliers and

private producers.

In its decision of December 8, 2008, the Electricity Authority set a rate arrangement for a

conventional private producer for a sale transaction of available capacity and energy to the

system manager. This decision states that the producer will be able to choose to allocate part

(or all) of the generation capacity of its facility to the system manager. The system manager

will be obliged to a predetermined gas quantity in return for this allocation. The system manger

will be obliged to the proportional share of the producer's gas transaction, even if the producer

does not use it.

d) In its decision on July 19, 2009, the Electricity Authority determined that the Company will

deposit a sum of money on behalf of every private producer in a dedicated account, equal to the

value of payments for two months, for the electricity the producer is expected to sell to the

Company. These funds will be used to secure payments to the producer. The decision also

establishes a rate arrangement applied between a private electricity producer and the essential

service supplier in the event of force majeure, insurance event, discriminating change in the law

and the rate arrangement derived from dividing the responsibility between the parties in the

purchase transaction.

e) The installed generating capacity of private producers (that do not generate for their own

consumption) at all voltage levels, at the time of signing this report, represents about 1.9% (228

MW) of the total installed capacity in Israel (12,014 MW). The private producers can be

divided into three main categories:

1. Private electricity producers from alternative energy sources (wind, water, sun, co-

generation) with whom agreements were signed for a total capacity of about 50 megawatts.

These power stations operate without the possibility of planning or controlling the level of

output (Must Run), and they are operated under District supervision.

77

2. Diesel power stations – Etgal, with a capacity of about 26 megawatts and Noga Paz, with a

capacity of 16 megawatts The Electricity Authority determined the rate for these power

stations on the basis of their actual generation costs.

3. A private electricity producer, IPP Ashkelon (with a capacity of 87 MW), started

commercial operation in 2008 without signing an agreement with the Company. The

producer is paid according to the co-generation rate, approved by the Electricity Authority.

4. A private electricity producer, Ashdod Refineries (with a capacity of 49 MW), started

commercial operation in July 2009 without signing an agreement with the Company. The

producer is paid according to the co-generation rate, approved by the Electricity Authority.

5. A private electricity producer Mashav Initiation & Development, (Nesher Ramla with a

capacity of 48.5 MW) completed acceptance tests in January 2010. The terms of the

agreement for selling their surplus electricity to the Company is being negotiated between

the parties.

f) For about a decade, the State tried to integrate private electricity producers in to the electricity

sector through the tenders method, so far with little success. As part of these attempts, the

Ministry of National Infrastructures published (in June 2001) a public tender for a private

producer for a combined cycle power station with a capacity of 400 megawatts at Mishor

Rotem. O.P.C. Rotem Ltd. won the tender, but disagreements with the State over the conclusion

of an agreement with the Company according to the terms of the tender delayed the execution

of the agreement and the case reached the High Court. The disagreements between the parties

were concluded and received the force of a court ruling on September 4, 2008 and the Board of

Directors of the Company approved the signing of the agreement on November 27, 2008

providing that the Electricity Authority was prepared to recognize all the costs, expenses and

damage that the Company could incur due to the agreement, for the purpose of setting the

recognized rate, and that the Ministers authorized the Company to handle any surplus or deficit

of natural gas of the producer according to the agreement, and subject to an examination of the

monetary guarantees to be submitted by O.P.C. Rotem Ltd., which had to meet the Company’s

needs. Upon receiving the required approvals, an electricity purchase agreement was entered

between the parties on November 2, 2009.

g) The State replaced the tenders method with the licenses method and any entrepreneur who

meets several basic conditions receives a conditional license that enables commencing

processes for building a power station. The total capacity of valid conditional licenses as of

February 15, 2010 is 3,492.7 MW consisting approximately 23% of the installed electricity

generation capacity in Israel as of February 2010.

h) During the last three years, the Company received dozens of proposals for private power station

projects at a total capacity of about 10,000 MW. The Company initiated a process to examine

possible integration of the suggested projects in the electricity grid. The process, conducted as a

feasibility study, was expanded and approved by the Electricity Authority in its decision 222,

on July 9, 2008, In this framework, 45 projects were examined. Once the entrepreneurs start

building power stations and producing and/or selling electricity, it may be expected that they

will supply part of the increase in electricity consumption, although the Company is unable to

estimate the scope, mainly in light of the uncertainty regarding the ability to implement

78

consolidated arrangement conditions to be agreed, prices of natural gas to the entrepreneurs and

their ability to find end consumers.

i) During the year ended December 31, 2009, the Company purchased about 261 million kWh

from private producers. In the year ended on December 31, 2008, the Company purchased

about 240 million kWh. The average price paid by the Company to private producers in 2009

was 44 agorot per kWh (58 agorot per kWh in 2008). The electricity purchased from these

producers in 2009 and 2008 represented about 0.5% and about 0.3% respectively of the

electricity supplied by the Company each year.

2.1.4.3 Renewable Energies

1) In March 2008 the State decided to publish a first tender for the construction of up to four solar

power stations in the Negev, with a total capacity of about 250 MW in solar thermal technology

and up to 30 MW in photovoltaic technology. The power stations will be constructed at the

Ashalim site in the Negev, in an area of about 4,000 dunams. The first stage of the tender (PQ)

was completed and the second stage of publishing the terms of the tender was completed at the

beginning of 2009. The tender is expected to be concluded in April 2010.

2) In June 2008, the Electricity Authority approved a rate for small solar photovoltaic facilities

with a total accumulated capacity of up to 50 MW.

3) The existence of small, business photo voltaic facilities with a capacity of 47 MW which were

build or approved was detected during December 2009. This capacity exceeds the quota as

specified in the decision of the Electricity Authority (35 MW out of the total quota of 50 MW,

allocated to such facilities). Another decision of the Electricity Authority states that all the

facilities that received the required approvals by December 14, 2009 will benefit from the rate

that was set for the initial arrangement. The Electricity Authority did not define an additional

quota for these facilities. The Company also addressed the Electricity Authority on the subject

of exceptional cases of consumers who are in different stages of the process with a total

capacity of 12 MW. The Electricity Authority did not reach a decision on these cases.

4) On September 7, 2009, the Electricity Authority published an arrangement for small wind

turbines.

5) On December 28, 2009, the Electricity Authority publishes an arrangement for medium solar

facilities (exceeding 50 kWh) connected to the distribution grid.

6) On December 10, 2009 the Electricity Authority published for a hearing an arrangement for

solar facilities connected to the transmission grid.

7) As of the publication date of this report, the Company cannot estimate the total number of

private producers using renewable energies and the installed capacity, which will be built and

operated as a result of the tender and in accordance with the aforementioned decisions of the

Electricity Authority.

2.1.5 Generating capacity

The following table shows the Company’s installed generating capacity (including private producers

included in the Company’s system of supervision and control of load), and peak demand in

megawatts for the years 2009 and 2008:

79

2009 2008 Installed generating capacity (IEC + Etgal)………………………. 11,690 11,675 Peak demand……………………………………………………… 9,900 (*)10,200 Available capacity during peak demand …………………………. 10,935 9,813

* This peak demand was measured on January 30, 2008.

The generation units Haifa B (2 X 72 MW) were removed from the generation system since January

2009. In 2009, the Company’s installed generating capacity increased by about 15 megawatts, due to

the following changes:

Haifa B unit, with a capacity of 144 MW ceased operation.

Reduced capacity of unit 3 at Eilat site by 7 MW due to topographic conditions.

Increased capacity of Hagit CCGT unit 2 by 48 MW, following transition to use of natural gas.

Commenced operation of gas turbine unit 6 at Ramat Hovav, with a capacity of 118 MW.

The following table specifies the various generating units, and their generating capacity in

megawatts at December 31, 2009, including electricity purchased from private producers and

included in the Company’s system of supervision and control of load:

Type of unit Site No. of units

Installed generating

capacity (in MW) Steam driven power stations

Dual purpose power stations Orot Rabin (Maor David A, B) 6 2,590

Rutenberg 4 2,250 Total dual purpose power stations (coal and fuel oil) 10 4,840 Dual purpose power stations (natural gas and fuel oil) Eshkol 4 912

Reading (*) 2 428 Total dual purpose power stations (natural gas and fuel oil) 6 1,340 Total dual purpose power stations 16 6,180 Power stations operating on fuel oil Haifa 2 282 Eshkol 2 150 Total power stations operating on fuel oil 4 432

Total steam driven power stations 20 6,612 Gas turbines

Industrial gas turbines Ramat Hovav 3 318 Tsafit 3 468 Alon Tavor 2 220 Eilat 1 34 Atarot 2 68 Gezer 4 592

Total industrial gas turbines 15 1,700 Jet gas turbines Hartuv 1 40

Eitan 1 40 Ra’anana 1 11 Caesarea 3 130 Haifa 2 80 Kinnarot 2 80 Orot Rabin 1 15

80

Type of unit Site No. of units

Installed generating

capacity (in MW) Rutenberg 2 40 Eshkol 1 10 Eilat 2 58

Total jet gas turbines 16 504 Total gas turbines 31 2,204

Combined cycle gas turbines Ramat Hovav 1 335 Hagit 3 1,019 Eshkol 1 377 Gezer 3, 4 2 744 Alon Tavor 1 373 Gas turbines intended for future operation as combined cycle

Tsafit

1

248

Total combined cycle gas turbines and gas turbines intended for future operation as combined cycle

9

3,096

Total generating units in the Company 59 11,664 Generating by private producers under Company supervision (Etgal Ashdod)

1 26

Total including private producers under Company supervision 60 11,690

81

2.1.6 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

82

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.

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.

83

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

Year Forecast peak

demand

Installed capacity

Available capacity in summer considering stoppages for

performing emission reduction projects in existing

coal power stations

Available reserve in summer

Available capacity in summer,

assuming a fault in the largest unit

Available reserve in summer,

assuming a fault in the largest unit

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)

84

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.

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

85

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.

2.1.7 Fixed assets and facilities

The details of fixed assets and facilities given below refer to property and assets held by the

Company or used by it, ignoring disputes between the Company and the State regarding the

Company’s rights to the aforesaid property and assets, which were in the Company’s possession

when the concession expired. (As for the “assets arrangement” and its implications for the

Company, see section 1.7.2 in this report.)

Site name Location Nature Area in sq.m.

1. Rutenberg power station Ashkelon Power station 1,492,600

2. Reading power station Tel Aviv Power station 227,861

3. Haifa power station Shemen Beach, Haifa Power station 355,964

4.* Hagit power station Near Elyakim Junction Power station 735,844

5. Gezer power station Near Nesher factory, Ramle Power station 451,200

6. Eshkol power station Ashdod Power station 470,055

7. Orot Rabin power station Hadera Power station 2,024,940

8. Ra’anana gas turbine Ra’anana industrial zone Gas turbine 27,631

9* Ramat Hovav gas turbine Ramat Hovav industrial zone Gas turbine/ switching

201,960

10 Atarot gas turbine Atarot industrial zone Gas turbine 38,194

11 Kinnarot gas turbine North of Tiberias Gas turbine 29,870

12 Hartuv gas turbine Beit Shemesh industrial zone Gas turbine 28,470

13 Alon Tavor gas turbine Alon Tavor Gas turbine 142,660

14 Eitan gas turbine Moshav Eitan Gas turbine 41,000

15 Eilat gas turbine Eilat Gas turbine 67,000

16 Tsafit gas turbine Tsafit Gas turbine 232,970

17 Caesarea gas turbine Caesarea Gas turbine 228,500

Total area: 6,796,719

* There is also a switching station in this power station

These assets are owned by the Company (but see note 1.g to the Financial Statements on the assets

arrangement) or held by it, in the framework of long term leases (mainly with the Israel Land

Administration) or under rights that were granted to the Company by the owners of the assets (e.g.,

easement or permission to use free of charge which is not a lease, or possession right with a process

of arranging it under a contract) or rights granted to the Company by Law. The aforesaid assets and

rights are subject to floating liens created by the Company to secure its obligations (see note 18.d to

the Financial Statements) and also part of these assets (three electricity generation turbines

purchased by the Company from Siemens, designated for installation at Ramat Hovav, Eshkol and

86

Hagit sites) are subject to permanent liens created by the Company to secure its obligations to

different financing entities (see note 3 e to the Financial Statements).

2.1.8 Intangible Assets

On the matter of the Company’s generating licenses and the provisions of the Electricity Sector Law

on granting generating licenses, see section 1.7.1 of this report.

2.1.9 Human resources

The generating segment has 2,310 permanent employees and 169 temporary employees as of

December 31, 2009 (see also Appendix A below.) For details on terms of employment, training and

other details, see section 3.7.2 of this report.

2.1.10 Raw materials and suppliers

a) The following table shows the breakdown in percentages of the fuel used in the generating

segment to produce electricity in the years 2009 and 2008:

For the period January - December

2009 2008

Coal 64.7% 64.9%

Fuel oil 1.2% 3.1%

Natural gas 32.6% 26.0%

Diesel 1.5% 6%

Total 100% 100%

Fuel costs accounted for about 59.4% of the Company’s operating costs in 2009, and about 68.7% of its operating costs in 2008.

b) The following table shows the total costs for fuel (including attributed labor costs) used to

generate electricity in the generating segment in the years 2009 and 2008:

Year ended December 31

in millions of NIS (of December 2009 purchasing power)

2009 2008

Coal 5,137 6,335

Fuel oil 244 933

Natural gas 2,236 1,632

87

Diesel 1,171 4,053

Total cost of fuels 8,788 12,953

c) The following table presents the average cost of fuel used by the Company in the years 2009 to

2008:

Year ended December 31

in agorot ((((of December 2009 per kWh)

2009 2008

Power stations operating on coal 15 17

Power stations operating on natural gas 12.9 11

Power stations operating on fuel oil 38 54

Power stations operating on diesel 142.9 120

d) All types of fuel used by the Company at the time of signing this report are purchased directly

or indirectly from sources outside Israel (excluding natural gas which at the date of this report

is also purchased from a local supplier - the Yam Thetis Group). An additional gas contract

with the Egyptian company EMG was signed in August 2005, and the gas started flowing in

May 2008 (for additional information, see section 2.1.10 in this report). As a result, the

Company and the State of Israel have almost no control over the availability of fuels in general

and any type of fuel in particular (regarding this risk factor see also section 3.17 herein). Any

disruption of fuel supplies could affect the Company’s operating results. In order to reduce the

negative effects of such disruptions, the Company keeps limited reserves of each type of fuel

used to generate electricity (except natural gas).

The Company estimates that its reserves of coal, fuel oil and diesel will be sufficient for

consumption of at least one and one half months.. The Company also has access to strategic

reserves of crude oil in the event of serious disruption of fuel supplies.

Pursuant to the reports of the finding of gas in the "Tamar" field, located about 90 km west of

Haifa shore, in January 2009, the Company is expected to open negotiations with the partners

on the purchase of gas from this field under the gas purchasing processes of the Company. If

the confirmation drills will be successful, the gas in "Tamar" field ensures, apparently, that a

certain portion of future purchases of gas (after the Yam Thetis reservoir is depleted) will

continue to be available from a local supply source, that is not affected by political issues

which affect gas supplied through pipelines originating abroad. It should be noted that the

depth and distance from the shore of "Tamar" field will require considerable investments in the

development of the field, including construction of a gas pipeline to the shores of Israel. This

process is expected to take 3-5 years, consequently, gas supply from this field is not expected to

start before 2012.

88

e) Coal

1) In the years ending on December 31, 2009 and December 31, 2008 the Company

consumed 12.3 and 12.7 million tons of coal respectively. The Company purchases all

the coal it requires through the National Coal Supply Corporation Ltd. (“the Coal

Company”), which is a fully owned subsidiary of the Company. See note 1.i. to the

Financial Statements. As of the date of this report, the Coal Company does not depend on

a single supplier.

On July 15, 2004, the Company and the Coal Company signed an agreement for

purchase, supply and delivery of coal to the Company’s coal fired power stations - Orot

Rabin in Hadera and Rutenberg in Ashkelon. The agreement was in force from

December 31, 2003 and will be in force as long as the Company holds licenses for these

power stations. The Company has the right to cancel this agreement by prior notice of

one year. The price paid is calculated on the basis of cost plus agreed profit, and subject

to the price of coal approved for the Company by the Electricity Authority. According to

this agreement, ownership of coal stocks passes directly from the supplier to the

Company, while the Coal Company will take care of transporting the coal to the power

stations, taking out suitable insurance (in favor of the Company) in the event of any loss

or damage to the coal.

In 2009 the adjusted average cost of a ton of coal was NIS 418 compared to 2008, when

the adjusted average cost of a ton of coal was NIS 499.

2) The Coal Company purchases coal (usually in the framework of supply contracts for at

least one year) from several sources. At the time of signing this report, the Coal

Company’s main sources of coal are in Africa, South America, Asia and Australia.

Company representatives participate in the negotiations that take place between the Coal

Company and their suppliers, particularly on matters of quality, availability and price.

Most of the Coal Company’s purchase of coal are on a FOB basis, but the price to the

Company includes the additional costs for transporting the coal and unloading it at the

production sites.

3) In order to ensure that sulfur dioxide emissions from the coal fired power stations are no

higher than the level stipulated in the standard applied to the Company (see section

2.1.13 of this report), the Company is required to use low sulfur coal. The Company

purchases coal with various percentages of sulfur from the Coal Company and burns

various types that ensure it meets these standards. As of the date of this report, the

Company complies with these restrictions.

f) Fuel Oil

1) In 2009 and 2008 the Company consumed about 0.2 and 0.4 million tons of fuel oil

respectively. At December 31, 2009 the adjusted average cost of a ton of fuel oil was

NIS 1,601.85 compared to the adjusted average cost of a ton of fuel oil in 2008, which

amounted to NIS 2,368.21. When the Company began using natural gas (see section

2.1.10 h below), consumption of fuel oil was reduced and this trend is expected to

continue as natural gas replaces fuel oil in additional generating units.

89

2) Fuel oil supply was based in 2009 on deliveries from Haifa and Ashdod refineries that

won the international tender published by the Company. The Company has an option to

extend the contract for another year. The suppliers are responsible for delivering the fuel

oil to the inlet of Haifa and Ashdod power stations or to the Company's marine

connections at Orot Rabin and Rutenberg sites. The Company pays prices based on CIF

LAVERA terms (trade prices in the Mediterranean Basin), plus a marketing margin. As

of the date of this report, the Company is not dependent on a single supplier.

3) In accordance with the Environmental Protection Order published by the Minister for

Environmental Protection in 1992, the Company uses low sulfur fuel oil with a maximum

sulfur content of 0.5%.

g) Diesel

1) In 2009 and 2008 the Company consumed 208,000 and 702,000 tons of diesel

respectively. In those years the Company purchased diesel on the local market from

local fuel companies, usually in the framework of supply contracts for one year. At the

beginning of 2007, the Company also began to import diesel from the Vitol company.

The price of the diesel is based on CIF LAVERA terms (trade prices in the

Mediterranean Basin), plus marketing margins, infrastructure costs and excise tax. From

the beginning of the year the Company purchased diesel for heating containing 0.2%

sulfur and in preparation for the new diesel standard that will become effective on

January 2010, the Company purchased in June 2009 diesel for heating containing 0.1%

sulfur only. In light of the inventory held by the Company and the fact that the Israeli

refineries are prepared to product diesel according to the required standard, the Company

is not dependent on VITOL.

The Company pays for diesel quantities ordered for delivery on a certain date according

to the price for the month of that order.

2) The prices paid by the Company for diesel are linked to world market prices, with

margins determined in competitive tenders between Company suppliers. In 2009 the

average adjusted cost of a ton of diesel was about NIS 5,623.29 compared to 2008, when

the cost to the Company was about NIS 5,774.66 per ton of diesel.

3) The diesel is brought to the Company’s gas turbine operated power stations mainly

through the national pipeline, or by tanker trucks to sites that are not connected to the

national pipeline..

h) Natural gas

1) In 2009 the Company consumed about 2,741,000 tons (about 4.04 billion cubic meters of

natural gas) at an average cost of NIS 815.85 per ton, while in 2008 the Company

consumed about 2,411,000 tons (about 3.54 billion cubic meters), at an average adjusted

cost of NIS 684.19 per ton. Gas began flowing to the Gezer site in July 2008 and to the

Hagit site in May 2009. As Company sites are connected to the natural gas

transportation system, consumption will gradually increase to 4-6 billion cubic meters

annually.

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2) The Company is engaged in converting industrial gas turbines operating on diesel to

operate on natural gas as well and also in the construction of new turbines. As of

December 31, 2009, five generating units at the Eshkol power station were running on

natural gas, with installed generating capacity of 1,285 MW, four of which are steam

driven power stations with installed generating capacity of 912 MW and one is of the

combined cycle type with installed generating capacity of 373 MW. Also, two

generating units at the Reading power station were operating on natural gas with installed

generating capacity of 428 MW. As of July 2008, 2 combined cycle gas turbine units

and 4 units of open cycle at the Gezer site have a total capacity of 1,064 MW. Gradual

operation of generation units at the Hagit site with a total capacity of 1,019 MW in three

combined cycles started since the end of May 2009. When the Company began using

natural gas (in 2004), the quantities of fuel oil it consumed declined (see section 2.1.10

(f) below). The reduction in use of diesel took place during 2008 after connecting the

Gezer site to the gas transportation system in July 2008. Connection of the Hagit site to

the gas transportation system in May 2009 further reduced the annual diesel consumption

of the Company. Connection of the sites of Ramat Hovav and Tsafit power stations to the

gas transportation system is expected during the first quarter of 2010. This information

is forward looking information, based on the development plans of the Company. This

information contains forecasts, subjective valuations, estimates and other plans of the

Company as of the signing date of this report, regarding work assumptions it used to

prepare the forecast and realization dates of these assumptions.

3) During 2009, about 63% of the natural gas was supplied by the Yam Thetis Group, which

holds the Mari natural gas marine reservoir, located about 24 km west of Ashkelon. The

agreement to supply natural gas was signed with the Yam Thetis Group in June 2002, as

detailed below. 37% of the gas was supplied by the Egyptian company EMG through a

marine pipeline from El-Arish to Ashkelon, enabling gas transportation from the

Egyptian gas system according to the agreement signed in August 2005, as detailed

below.

4) Agreements for Purchasing Natural Gas

1. Purchase of Natural Gas from the Yam Thetis Group

In June 2002 an agreement to supply natural gas was signed with the Yam Thetis Group,

according to which the Group will supply the Company with natural gas for 11 years

from the date it begins flowing, or until total consumption reaches 18 billion cubic

meters (about half the amount of natural gas the Company needs for the coming decade),

whichever is the earlier. The total value of the agreement with Yam Thetis is about USD

1.8 billion. The agreement includes an undertaking by the Company to pay for a

minimum quantity of natural gas, whether or not the Company actually consumes it

(“Take or Pay”). The quantity of gas paid for but not consumed in specific periods will

be available to the Company in the following periods, subject to the terms of the

agreement. Since February 2004 natural gas has been supplied according to the

agreement.

In July 2009, the Company entered a second agreement with Yam Thetis Group for the

purchase of additional quantities of natural gas in an annual amount of 1 billion cubic

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meters (BCM) for the next five years. The balance of the gas quantity to which the

Company was entitled on June 30, 2009, under the gas agreements with Yam Thetis

Group (the first agreement in June 2002 and the second agreement in July 2009),

amounted to about 11.2 BCM, of which 6.2 BCM remained from the first agreement

2. Purchase of natural gas from the EMG company.

On July 21, 2005, the Board of Directors of the Company approved the agreement that

the Company reached with EMG for supply of natural gas. According to the agreement,

the quantities of gas to be purchased (about 25 BCM) will be at an average annual rate of

1.7 BCM for 15 years with an option for the Company to extend it for a further 5 years

on the same terms and for the same annual quantities. To exercise the option, the

Company must give notice of 36 months before the end of the basic period.

On July 31, 2005, the Government approved the aforementioned decision of the Board of

Directors, in accordance with section 11(a)9(a) of the Government Companies Law.

The supply of the gas started in May 1, 2008, where at the end of the two month running-

in period, the contractual gas supply period began (on July 1, 2008).

Since the beginning of the gas supply by EMG in May 2008 and the beginning of the

contractual obligatory supply in July 2008 and up to mid June 2009, the supplier did not

fulfill its contractual commitments. According to the supplier's statements, there is a

general shortage of gas in Egypt due to delayed developments of new gas fields, which

limits supply volumes; demand for gas that exceeds forecasts and failures in the supply

system caused by the overload applied to gas supply and treatment systems. Since the

second half of June 2009, the supplier fulfills its supply obligations. Pursuant to an

amended gas sales agreement between the Egyptian Government and EMG, the parties

have concluded the terms for updating the original agreement, entered on 2005, while

adapting it to the developments since then. The Audit Committee and the plenum of the

Company's Board of Directors approved this update of the agreement.

The main amendments to the agreement are: a) Change in the price of natural gas and defining a periodic price update mechanism. b) Reduction in quantities that the Company is committed to purchase under the

agreement. c) Defining means to ensure reliable gas supply.

3. Purchase of natural gas from Yam Thetis Group on SPOT basis

In August 2006, an agreement was signed between the Company and the Yam Thetis

Group to arrange increased hourly consumption of gas at peak demand periods, above the

quantity committed to in the basic agreement. The gas to be supplied under this

agreement will be charged at a different rate, higher than the price in the basic

agreement, and lower than the price of fuel oil. The SPOT arrangement does not bind the

parties to any obligations but it does regulate the price of the additional gas, if it is

supplied. This agreement, and also the SPOT arrangement and its terms were extended

several times until June 2009. This arrangement ended in June 2009, when the second

agreement on gas purchased from Yam Thetis Group became effective.

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5) Agreement Of Intention to Supply Natural Gas from the Tamar Field and Natural Gas

Storage Services in Mari-B Field

Under the gas procurement process, which started in 2007, the Company reached an understanding with the stakeholding companies in Tamar Field, located about 90 km west of Haifa, on the principles of gas supply from this field, for a period of 15 years, starting on July 2013. The parties entered a letter of intent (non-obligatory) on December 13, 2009, that concluded the quantities and price formula. On December 24, 2009, the Company's Board of Directors approved the letter of intent as the basis for negotiations on a binding contract and the Company reported this to the Securities Authority on December 27, 2009.

In addition, the Company concluded a letter of intent (non-obligatory) with Yam Thetis Group, that produces gas from Mari-B field, opposite Ashkelon shores, whereby the Group will provide natural gas storage services to the Company from this field. The starting date for providing the storage services will be concluded in a detailed contract that will allow the Company to store gas reserves in Mari-B field from the beginning of the regular gas supply from Tamar Field, to be used by the Company during disruptions in gas supply from current gas sources or during peak demands.

Based on these two letters of intent, the parties intend to conclude detailed agreements within six months that will be submitted for the approval of the authorized committees.

6) Agreement to Transport Natural Gas

In June 2006, the Company signed an agreement with Israel Natural Gas Lines Company

Ltd. (hereinafter “the Gas Lines company”) to transport natural gas, under a formula

published by the Natural Gas Authority, and which will apply to all consumers of natural

gas who sign agreements with the Gas Lines company.

The agreement regulates the commercial, technical and legal rules for piping natural gas,

for a period of 15 years. This agreement was signed for the Eshkol and Reading sites, as

the Electric Corporation had reservations about a number of issues in the agreement. On

May 31, 2007, the Gas Authority published a general formula for agreement on piping

gas between the Gas Lines Company and consumers in the economy. In February 2008

the Board of Directors approved the wording of a permanent natural gas transport

agreement between the Company and the Gas Lines Company, replacing the June 2006

agreement. The new agreement was signed in January 2009.

Under the agreement, the Electric Corporation was granted flexibility regarding orders

for capacity by means of the right to shift up to 15% of the ordered capacity and by the

right to order capacity for the short term (for a full month minimum). This agreement

shall stay in force for 15 years, applying to all sites to be connected to the gas pipeline.

7) The project to set up a natural gas piping system (hereinafter: “the Project”)

According to the agreement signed in November 2004 and the additions to that

agreement of December 19, 2005, July 17, 2007, February 19, 2009 and February 22,

2009, between the Gas Lines company, the Government of Israel and the Company (“the

tripartite agreement”), the Company was charged with funding, ordering and managing

the work to set up part of the natural gas pipeline system in Israel as specified below. In

addition, it was agreed that the Company would not act as or be deemed the main

contractor or the executing contractor for the Project, unless such responsibility was

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imposed on the party ordering the work by law. The Project includes setting up a marine

system for piping natural gas, a receiving station in Ashdod including a sluice gate

station and pipe corridor from the coast to the station site (construction works will be

managed by the Gas Lines company), a marine segment from Ashdod to the Reading site,

a receiving and measuring terminal in Reading, a marine segment from Reading to Dor

beach, connection to the Hadera coast, including an over-land segment from the Dor

beach to the Hagit site, and a measuring terminal at Hagit.

The main points of the tripartite agreement are as follows:

(a) The role of the Company is to finance the Project, manage it and order the work

required (including, but without detracting from the generality of the above,

selecting contractors, making agreements with contractors, fully coordinating

between contractors regarding their work and schedules, managing execution of

the work, taking the necessary actions to ensure contractors comply with their

obligations, doing everything required to purchase and arrange all rights to the

land needed for the Project, obtaining building permits and other permits, and

handling payment of compensation to owners of the land).

(b) The Company will not be the owner of the system and will have not rights to it or

any part of it, and the system will be owned by the State.

(c) In return for execution of the Project, the Company will be entitled to

reimbursement for all its expenses (including financing expenses - as specified in

the tripartite agreement) incurred for the Project and included in the Project's

budget, or approved by the competent body, as defined in the tripartite agreement

(the Comptroller General in the Ministry of Finance, the Director General of the

Ministry of National Infrastructures, and the CEO of the Gas Lines company

(hereinafter: “the competent body”)) and to management fees of between 10 and

14 million dollars, so that the Company does not expect any material profit or loss

from this project. The competent body may set off against the costs reimbursed to

the Company any expense or damage incurred by the state and/or the Gas Lines

company as a result of negligence of the Company to fulfill its obligations

according to the tripartite agreement or breach of the tripartite agreement by the

Company. This liability of the Company is limited to 20 million dollars during the

warranty period, and to 20 million dollars after this period (even if the limit of

liability was fully or partially utilized during the warranty period). If the damage

caused by the Company’s negligence amounts to more than 20 million dollars, the

excess will be deducted from the management fees paid to the Company. For the

project, insurance was purchased covering damage likely to be caused to the

project and to third parties. In addition, the Company is covered for professional

liability in the framework of its general third party liability insurance. As of the

date of this report, the Company is in contact with the insurers regarding claims

filed against it by the State, the Gas Lines company and third parties. The contacts

have not been completed and the official position of the insurers has not yet been

received.

On the matter of reimbursement of approved expenses, it states:

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(a) The Gas Lines company will pay the Company all the amounts due according to

the payment schedule (hereinafter: “reimbursed amounts”) for the loans that the

Company received and will receive from Citibank to finance the costs of the

Project (see below), at the time each of the reimbursed amounts is paid according

to the payment schedule (back to back). Until the whole Project is delivered, only

the relative part of the costs relating to delivered parts of the system will be

reimbursed.

(b) The reimbursed amounts will also include payments actually made by the

Company to the State for commissions on the State guarantee and other

commissions and expenses paid by the Company for the aforesaid loans.

(c) The Gas Lines company will begin paying the Company the reimbursed amounts

as aforesaid only after the date when gas flow starts on the Ashdod - Reading

segment, or when the segment is agreed to be complete, whichever is the earlier,

subject to certain conditions.

(d) The amounts that the Company previously set off against the transmission rate

(amounting to about $19.2 million) will remain with the Company, as a down

payment on account of the Gas Lines company payments to the Company, and will

first be reduced according to paragraph (a) above.

The approved costs will be calculated and reimbursed in US dollars. The

Company’s liability in this Project is derived from the obligations and tasks

imposed on it in the tripartite agreement. These tasks may also impose on the

Company liability under law, including the safety at work laws. The Company’s

responsibility for the system’s “good working order”, as defined in the tripartite

agreement, is limited to the period of the warranty given to the Company by the

contractors with which it signs contracts, on condition that it is no less than the

minimum period specified in the agreement - up to the end of 18 months from

when completion approval is given or at the end of 12 months from the start of

system operation, whichever is the sooner. (However, it should be noted that the

Company does not receive an overall warranty for the system from the contractors,

but each contractor is only responsible for the work it does).

In January 2005 damage was detected in the marine segment of the pipeline. This

damage was repaired by the contractor in view of its liability, according to the

agreement between it and the Company, where in the Company’s opinion the

repair was successful and the Company has confirmation of this from the

regulating entities. During the preparations for the repair work, the Gas Lines

company and the competent body instructed the Company to do the repair in a

different way, but following these demands would have meant an extra expense of

tens of millions of dollars, especially since the Gas Lines company had, at an

earlier stage, approved execution of the repair with the method used. The

Company also received explicit instruction from the Minister to continue with the

repair in the way it was done. Notwithstanding repeated requests from the

Company to the competent body for explicit instructions on this matter, with an

undertaking by the competent body to bear the financial costs of any instruction,

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no specific response was received. In these circumstances the Company decided to

complete the repair in the way it was started, among other things considering the

fact that this would not preclude a later repair by another method. If the Company

is required in future to carry out the repair by the other method, the expected cost

will be about $30 million.

It should be noted that the Company completed, in February 2009, construction of

a project for which it is responsible pursuant to the tripartite agreement. The State

and the Gas Lines company subjected gas delivery to the last segment to the

condition of receiving additional commitments from the Company, based on

additions No. 3 and 4 to the tripartite agreement. These additions were signed on

February 19, 2009 and February 22, 2009 respectively. Gas delivery through the

last segment started on February 23, 2009.

These additions oblige the Company as follows:

a) On the repair of the Northern line:

The Company will incur 50% of the actual total cost of the additional repair, up to

a ceiling of $ 15 million ("Additional Repair Costs") in return for presentation of

the additional repair costs budget and presentation of proper confirmation on the

actual additional repair costs. If no decision will be issued in the administrative

arbitration between the parties (see below) up to October 30, 2011, the additional

repair costs will be returned to the Company.

Any amount exceeding the additional repair costs will not be funded nor paid by

the Company, without derogating any claim of any party, as presented during the

decision process.

If the decision states that the Company is not required to incur the additional repair

costs or if no decision is issued up to October 11, 2011, whether repair work was

started or not, the liability of the Company will expire and if the Company

incurred any amount as a result of this liability, the Gas Lines company will return

this amount with linkage differences and interest at the legal rate to the Company

within 60 days from decision receipt date or up to October 30, 2001, as the case

may be. If the decision states that the Company incurs partial responsibility for

performing the additional repair, the stipulations of this paragraph on the refund

related to the additional repair costs according to the responsibility ratio division

determined by the decision will apply.

If the decision, issued up to October 30, 2011, states that the Company is

responsible for the additional repair, the commitment of the Company, according

to the division of responsibility between the parties, as stated in the decision, will

remain in force for a period of 25 years from the signing date on this addition to

the agreement.

If the decision states that the Company is responsible for the additional repair, the

Company will be obliged to refrain from filing claims against any of the parties in

this agreement with respect to damages incurred due to stopping the delivery

required to perform the additional repair. Nevertheless, nothing in the

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aforementioned derogates from the rights of the Company according to the

delivery agreement and subject to its stipulations, insofar as the contractors who

will actually perform the repair will be grossly negligent in their work.

If the Director General of the Government Companies Authority decides in favor

of the Company in the arbitration, the Company will be obliged to refrain from

receiving, claiming or demanding an additional refund of the additional repair

costs, in excess of that stated in the decision.

b) Additional Commitments :

The Company took upon itself to attend to a list of open issues that still remain

after completion of the Project, including, obtaining completion certificates,

landscape rehabilitation, cathode protection and more and also extended the

obligation to incur cost of works that will be performed by the Gas Lines company,

up to an amount of $ 10 million and works up to an amount of $ 0.5 million. To

warrant fulfillment of the obligations or the Company, the Company agreed that an

amount of approximately $ 16 million, held by the Gas Lines company will not be

released immediately upon gas delivery to Hagit (according to the second addition

to the agreement), and will be released in stages, where if all the obligations of the

Company are not fulfilled within 3 years, the State will hold about 10% of the

amount, until the obligations are fulfilled.

In 2006, several disputed issues were raised between the Company and

representatives of the State regarding the tripartite agreement: execution of the

Project, reviewing the extent of the damages and responsibility for these damages

and resulting repair works required.

Following numerous requests by the Company, the Director General of the

Government Companies Authority, was appointed as the arbitrator in the dispute

between the Company and the State and the Gas Lines company during June 2008.

In December 2008, the Company submitted to the arbitrator its claims against the

State and the Gas Lines company, including its demand to receive compensation

for repair expenses it incurred and state that the State will assume responsibility

for paying the compensations to third parties, decided by the arbitrator, if any.

Claims of the State and Gas Lines against the Company under these proceedings

were received on January 28, 2009 and in July 2009 a response document was

received, completing the claims of the State and the Gas Lines company. A

completing response document on behalf of the Company was submitted in August

2009. At this stage the Company is studying the claims of the State and of the Gas

Lines company. The State and the Gas Lines company raised various claims

against the Company which were not quantified precisely, but may amount to tens

of millions of U.S. Dollars. The parties are currently awaiting the appointment of a

new arbitrator, since the Director to the Government Companies Authority ended

his term of service.

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The Company completed the construction of the project for which is was

responsible according to the tripartite agreement, a few months ago. See more

details in Note 13 g to the financial statements.

2.1.11 Working Capital

The Company operates as one integrated and coordinated system, and therefore its working capital

is examined in terms of the Company as a whole (see section 3.9 of this report). However, details

are given below of the policy of holding stocks of fuel allocated to the generating segment:

a. Coal: the Company’s policy is to maintain a reserve suitable for average consumption of seven

weeks (in each of the power stations), and avoids going below the stock needed for five weeks.

In the event of a fault in the coal unloading system, the coal is moved from one site to another

in accordance with the Company’s existing emergency procedures.

b. Fuel Oil: the Company’s policy is to maintain a reserve for two months of average

consumption. Orot Rabin and Rutenberg are strategic sites for the Company. In the event of an

emergency, fuel oil will be moved from these sites to the steam driven power stations.

c. Diesel: the Company’s policy is to maintain a reserve of no less than 165,000 tons (as an

emergency reserve) or stock that can meet the needs of 100 hours of operation (whichever is the

larger). Apart from this stock, the Company has operating stock in the gas turbine sites and the

storage terminals. The stock is spread among the fuel terminals according to the location of the

gas turbine sites.

2.1.12 Restrictions and regulation of the generating segment activity

The generating segment is subject to the provisions of the Electricity Sector Law, the regulations

drawn up by virtue of it, and the provisions of the generating licenses granted to the Company (see

sections 1.7.1 to 1.7.3 in this report).

In addition, the generating segment is subject to regulation and restrictions by virtue of the Planning

and Construction Law 1965 and the Business Licensing Law 1968 as well as various environmental

legislation, as specified in sections 2.1.3 and 3.12.11 of this report.

2.1.13 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

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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

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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 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

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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. 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.

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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.

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

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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.

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.

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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

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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.

2.1.14 Material Agreements

The agreements described below are material agreements outside the Company’s normal course of

business that are not described in other sections of this report.

a) Agreements involving the supply of natural gas

The Company has a number of arrangements with the Government and with government

companies for the supply of natural gas, including:

1) Agreement to build a natural gas piping system: the Company signed an agreement to set

up part of the natural gas piping system with the Government and with the Gas Lines

company (a company fully owned by the State) - see section 2.1.10 in this report. As of

December 31, 2009 and December 31, 2008, the balance of the long term obligation for

this project amounted to NIS 1,049 million and NIS 1,098 million respectively.

2) Indemnification for the State of Israel: the Company has submitted indemnification

documents to the State (Ministry of Defense) in connection with damage that could be

caused to the State due to the passage of a gas pipeline through land belonging to the State,

for any damage, expense, payment or loss incurred by the Ministry in the event that the

undersea pipeline is not laid according to the provisions of the coordination agreement

signed in this context. For details see note 13(h) to the Financial Statements.

3) Agreement to Conduct Natural Gas, see section 2.1.10 in this report.

2.1.15 Legal proceedings

a. Appeal of the Yerukim Party for Life and Environmental Quality in Israel

On October 26, 2008, the Yerukim Party and its leaders filed an appeal to the sub-committee

for appeals of the National Planning and Construction Board, on the decision of the Coastal

Environment Protection Committee, of August 20, 2008, approving the construction of Project

D. The appeal claimed that the plan was approved while the Coastal Environment Protection

Committee did not have the full factual basis on the effect of a coal power station on the coastal

105

environment, when the Company did not receive the legal building permits (required before the

approval of the Coastal Environment Protection Committee), while alternatives to reduce the

effect of the coastal environment were not reviews. The appeal also claims that implementation

of the plan will cause severe damage to the coastal environment. On June 7, 2009, the sub-

committee for appeals issued its decision, rejecting on the threshold the appeal of the Yerukim

Party, since the appealers had no right to appeal the decision of the Coastal Environment

Protection Committee.

b. Appeal to the High Court of Justice by Adam Teva Vedin, an Israeli Society for Protection of

the Environment and by the Yerukim Party, for Life and Environmental Quality in Israel

On June 26 and 29, 2008, two appeals requesting an order nisi and an interim order were filed

against the decision of the Committee for Building and Planning to approve the forwarding of

the plan to build an additional coal power station in Ashkelon, Project D, to the comments of

the district committees and comments of the public.

The appeal requests the respondents to provide reasons for the following: reason for not

cancelling the decision of the Committee for Building and Planning to approve the forwarding

of the plan which is the subject of the appeal until the full required information is presented to

the committee, the reason of the Government of Israel for not reconsidering its position and for

not holding the discussions on the alternatives for this project by the Government; the reason

for not exercising their authority for allowing their objections to be heard and considered

during the decision process of the Government; the reason for not forwarding the plan for

discussion in the National Board by force of its being the entity that represents, through its

members, all the parties related to a decision of the said type; the reason for not subjecting the

continuation of the process in the Committee for Building and Planning to receiving the

approval of the Coastal Environment Protection Committee, in accordance with the provisions

of the Coastal Environment Protection Law, 2004 (already approved by the time of submitting

the appeal).

The decision, issued on June 29, 2008, states that both appeals will be heard together and the

response to both appeals will be issued together. The request of the applicants to issue an

interim order to avoid and promotion of the plan and also avoid performance of any work at the

site, arising from the plan was rejected.

The date for hearing the appeal was set to November 11, 2009 (after the court postponed the

hearing date twice, in its own accord). On November 11, 2009, the High Court of Justice

recommended that the applicants withdraw their appeal, on the grounds of being premature, and

the applicants accepted this recommendation.

Regarding legal proceedings pending against the Company, including proceedings for the generating

segment, see note 24 to the financial statements.

2.2 The Transmission and Transformation Segment

2.2.1 General information about the transmission and transformation segment

The Company transmits electricity in the framework of transmission, distribution, supply, sale of

electricity and trade in it. This license, with all the activities it includes, was extended by

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amendment No. 8 to the Electricity Sector Law up to January 1, 2011.

It should be noted that the Company has not received a new, separate license for the transmission

activity, and therefore this activity is carried out according to the format of the aforesaid combined

license (which as stated referred to a number of activities).

The Company’s transmission grid covers the whole of the State of Israel and territories under the

rule of the State of Israel since June 1967. The transmission grid consists of ultra high voltage lines

(400 kwh) over which electricity is sent from the generating units to the main switching stations,

which distribute and transform the electricity using transformers and high voltage lines, to

secondary stations located all over the country. From the secondary stations the electricity is sent to

end users through the distribution system (see section 2.3 in this report).

For information on management of the system as determined in the different amendments of the

Electricity Sector Law, see paragraph 1.1.7 sub-section 1 in this report.

a. Structure of the Segment

As aforementioned, the Company's operation in this segment is transmission and transformation

of electricity generated in the different generation units of the Company to secondary stations

located throughout Israel. As of the report date, the Company transmits all the electricity in

Israel, supplies part of it the high voltage consumers and transforms and transmits the

remaining part to districts of the Company.

b. Limitations of Laws, Standards and Specific Constraints Applied to this Segment

The Company estimates that its operations in the transmission and transformation segment,

similar to its other fields of operation, are subject to legal limitations, such as limitations

stipulated in the provisions of the Electricity Sector Law and the Government Companies Law

and to constraints arising from licensing issues and licenses required by different Government

authorities and ministries, e.g., the Electricity Authority, the Government Companies Authority,

the Ministry of National Infrastructures and the Ministry of Environment, and to structural

changes and emergency and development plans for the Electricity Sector.

c. Trends and Changes in the Field of Operation and its Profitability

The Company estimates that several factors may affect the volume of operation and

profitability of this segment, such as changes in electricity consumption and changes in

electricity rates.

The main trends and changes are as follows:

1. Decreased demand for electricity and extended planning criteria may lead to building

fewer secondary stations,

2. The Company acts decisively to reduce construction costs of secondary stations by

building open secondary stations in most cases, and reducing prices of all components of

the stations.

c. Construction of a higher number of private high and ultra high voltage secondary stations

(for private electricity producers and for consumers) will lead to a higher investment of

work hours for commissioning, tests and maintenance.

107

d. Updates in the tenders law will encumber purchasing processes and prolong their

duration..

c. Changes in criteria will require higher payments, as indemnification to electricity

producers and to consumers connected to high and ultra high voltage grids.

d. Technological Changes that may have a Material Effect on the Field of Operation

The Company generates, transmits, distributes and sells electricity to all the consumers in the

State of Israel. It is not aware of any technological changes that may have a material effect on

this field of operation.

As of the date of this report, the Company acts to build secondary stations while reducing the

costs of all the station's components, including installation of transformers (75 ??) with current

limiters in the urban secondary stations, to increase the capacity of current secondary stations

and introducing new technologies (e.g., ACSS wires) to increase the capacity of the current

transmission lines.

e. Critical Success Factors of Changes to the Field of Operation

The Company estimates that the business success of the transmission and transformation

segment depends, inter alia on the demand for electricity level, the maintenance and operation

costs of the transmission and transformation facilities, the recognition of the total costs required

to transmit electricity in the electricity rate and in the ability of the transmission and

transformation segment to be more efficient from both structural and technological aspects. See

also sections 1.7 and 1.8 in the report.


As explained above, the Company operates as one combined and coordinated system, to supply

electricity to consumers, from the generation of electricity at production sites, through its

transmission and transformation, to its distribution and supply to the end users. See section 3.3 in

this report.


a) Future Electricity rate - transmission and transformation segment

In its document for a hearing, published in July 30, 2008, the Electricity Authority stated that

the document for a hearing is one stage for setting recognized costs for all the segments in the

electricity chain (generation, transmission, distribution and delivery), scheduled to be

performed during 2009. The document also states that the Electricity Authority considers it is

very important to have a correct and up to date definition of the transmission segment activity

before its costs are determined, since this is a unique segment that provides essential services to

the Company and to private entities operating in the electricity sector. In view of this, the

Electricity Authority deems it is essential for the Company to act immediately and make

administrative arrangements to enable this segment to operate as a distinct, consolidated

segment in the framework of an essential service provider license. The costs involved in such

preparations will be included in the recognized costs of the segment, insofar as such

preparations are made. The transmission segment will include the following activities:

Forecasting market demand and consumption, ultra planning, simulations of system stability

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from both the generation and consumption ends, integration and supervision and control actions

over the whole electricity delivery in the system, including trade management mode.

b) Revenues

The net revenues from electricity sales attributed to the transmission and transformation

segment (see note 38 to the financial statements) in 2009 amounted to some NIS 1,685 million,

compared to about NIS 1,711 million in 2008, a decrease of NIS 26 million in revenues.

This was mainly due to the attribution of costs for assets from the generation and distribution

segment to the transmission segment.

c) Profit from regular activities - transmission and transformation segment

Profits from regular activities in the transmission and transformation segment in 2009 were

about NIS 536 million, compared to NIS 537 million 2008, a decrease of some NIS 1 million.

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2.4 Capacity of the transmission and transformation system

a) Transmission system (Voltage Lines):

December 31 400 kwh lines

km circuit

161 kwh lines

km circuit

115 kwh lines

km circuit

161 kwh

km circuit

2009 738.6 4,141 132 94

2008 738 4,128 132 94

On December 31, 2009, and December 31, 2008, the installed capacity of a 400/161 kWh

connection transformer was 10,000 megavolts.

Transmission of ultra high and high voltage electricity enables transfer of energy between the

generating power stations and load centers, with low losses.

b) Transformation system

1) On December 31, 2009 the transformation system covered 197 secondary stations (of

which 40 were owned by consumers); compared to 199 secondary stations (of which 40

were owned by consumers) on December 31, 2008.

2) On December 31, 2009, the installed transformation capacity was 16,889 megawatts

(including 2,524 megawatts for secondary stations owned by consumers)compared to an

installed transformation capacity was 16,664 megawatts (including 2,524 megawatts for

secondary stations owned by consumers) on December 31, 2008

The following table shows the number of switching stations and secondary stations

(belonging to the Company and to consumers), by type, on December 31, 2009 and 2008:

Type of station:

Year:

Switching stations

Secondary stations

Private stations

Total

31/12/2009 9 148 40 197

31/12/2008 9 148 40 197

The material changes in the transformation system which occurred in 2009 are:

commissioning external secondary stations: Kamon, Nahal Shehoret and Shoham;

positioning mobile secondary stations: Shderot temporary and Imanuel 2; disassembly of

mobile secondary stations: in Nahal Shehoret, Karmiel 2,3, Shoham, Jerusalem B and

eastern mobile C; and additional transformers at Ashdod.

2.2.5 Fixed Assets and Facilities

The details of fixed assets and facilities given below refer to property and assets held by the

Company and/or used by the Company for this field of operation, ignoring any disputes between the

Company and the State regarding the Company’s rights to such property and assets which were held

by the Company when the concession expired. (Regarding the assets arrangement and its

implications for the Company, see note 1.g to the financial statements.)

The transmission and transformation segment has switching stations at various locations as shown in

the following table:

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Site name Location Nature Area in sq.m.

Caesarea switching station* Caesarea Switching station 228,500

Tsafit switching station* Near Kfar Menachem Switching station 232,970

Petach Tikva switching station Near Morasha Junction Switching station 65,073

Zevulun switching station Kfar Hassidim Switching station 272,045

Gan Shorek switching station Rishon Lezion Switching station 206,500

Even Sapir switching station S.W. of Moshav Even Sapir Switching station 104,000

Gezer* Near Ramle Switching station 201,960

Yavneh switching station Ashdod Junction Switching station 100,117

Total area: 949,695

* The area of the aforementioned switching stations in included in the area of the related power

station site, as detailed in section 2.1.7 in this report.

The transmission and transformation segment has 9 switching stations, 109 permanent secondary

stations, 18 temporary secondary stations and 21 mobile secondary stations in action all over the

country, covering 1.9 million sq./m.

These assets are owned by the Company (but see note 1.g to the Financial Statements on the assets

arrangement) or held by it, in the framework of long term leases, or of rights that were granted to the

Company by the owners of the assets (e.g., easement or permission to use free of charge which is not

a lease, or possession right with a process of arranging it under a contract) or rights granted to the

Company by law. The aforesaid assets and rights are subject to floating liens created by the

Company to secure its obligations (see Note 18.e to the financial statements).

2.2.6 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.

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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.

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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).

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.

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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.

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.

2.2.7 Intangible assets

Regarding the Company’s transmission license and the provisions of the Electricity Sector Law

regarding licenses, see section 1.7.3 of this report.


As of December 31, 2009, the transmission segment employs 395 permanent workers and 50

temporary workers (not including operating staff on transmission lines, which are organizationally

attached to the distribution Districts - see section 2.3.9 in this report). (See also Annex B below.)

For details of the terms of employment and other details see section 3.7 in this report.

2.2.9 Environmental quality - transmission and transformation segment

For the environmental aspects involved in obtaining licenses under the Planning and Construction

Law, see sections 2.1.13 and 3.12 of this report.

For the environmental effects of non ionizing radiation and electromagnetic radiation see section

2.3.10 of this report.

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2.2.10 Restrictions and regulation of the transmission and transformation segment activity

For licensing procedures according to the Planning and Construction Law, see section 3.12 of this

report.

For the criteria for the infrastructure services that the Company is obliged to provide for private

producers, including the criteria in October 2005, see section 2.1.4 of this report.


For legal proceedings and indemnification documents given by the Company in accordance with

section 197 of the Planning and Construction Law, see note 24 to the financial statements.

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2.3 The distribution segment

2.3.1 General information about the distribution segment

2.3.1.1

a) On December 31, 2009, the Company’s distribution system consisted of lines with voltages of

33 MVA, 22 MVA and 12.6 - 6.3 MVA (high voltage lines), low voltage lines and distribution

transformers.

b) The Company supplies most consumer with low voltage electricity, and large consumers with

high voltage electricity.

c) The distribution segment is divided into five districts, covering the whole country, through

which the major part of the Company’s work connections and service to its customers takes

place: at the time of signing this report they numbered 2.5 million.

1) The northern District covers all the northern Districts of Israel, from the Alexander River

in the south, excluding Haifa and its environs. The District’s activity along the

Lebanese, Syrian and Jordanian borders, and at the south eastern side along the seam

line, is conducted in the framework of security restrictions. In 2009, this District served

some 398,000 customers, compared to 391,000 in 2008. This District is characterized by

a scattered population, with a large number of small towns and villages, and long

distribution lines.

2) Dan District is bounded by Road 5, Glilot Junction in the north, Bar Ilan and Or Yehuda

in the east and the town of Holon in the south. This is the most densely populated of all

the Company’s Districts, because of its urban nature. Therefore, most of the distribution

grid in the Dan District is underground. In 2009 this District served about 538,000

customers, compared to 533,000 in 2008.

3) The Jerusalem District covers Greater Jerusalem, Beit Shemesh, Har Tuv, Har Hevron

and its south, Samaria including the town of Ariel, the Jordan Valley between Ein Gedi

and Mechula. Because of its location, this District bears the main burden of the

Company’s work in the Judea and Samaria areas on a daily basis. The activity is

possible thanks to the removal of electricity supply from the dispute, and thanks to the

cooperation with the East Jerusalem Electric Company. In 2009 this District served

about 273,000 customers, compared to 269,000 in 2008. In addition to the number of

registered consumers, the district ensures electricity supply to about 250,000 Palestinian

consumers.

4) The Southern District is the largest of the Company’s Districts, stretching from Emek

Hefer in the north to Eilat in the south, excluding the Dan District which includes greater

Tel Aviv. In accordance with its size, this District serves about 40% of the Company’s

customers. In 2009 the southern District served about 978,000 customers, compared to

961,000 in 2008. Activities of the district along the border with Gaza is subject to

security limitations and sometimes under fire.

5) The Haifa District covers Haifa and its environs, from the South Acre Industrial Zone in

the north, Shefaram and Mishmar Ha’emek in the east, Bat Shlomo in the south and the

Carmel Beach settlements in the west. This District is largely a densely populated urban

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area, and therefore about one half of the grid lines in it are under ground. In 2009 the

Haifa District served about 266,000 customers, compared to 263,000 in 2008.

2.3.1.2 Structure of the Segment

As aforementioned, the Company's operation in this field is distribution of electricity from

secondary stations through high voltage and low voltage lines and delivery and sale of

electricity to consumers. As of the report date, the Company distributes, delivers and sells all

the electricity in Israel.

2.3.13. Limitations of Laws, Standards and Specific Constraints Applied to this Field

The Company estimates that its operations in the distribution segment, similar to its other fields

of operation, are subject to legal limitations, such as limitations stipulated in the provisions of

the Electricity Sector Law and the Government Companies Law and to constraints arising from

licensing issues and licenses required by different Government authorities and ministries, e.g.,

the Electricity Authority, the Government Companies Authority, the Ministry of National

Infrastructures and the Ministry of Environment, and to structural changes and emergency and

development plans for the Electricity Sector. The electricity distribution activity is performed

in accordance with the license granted to the Company, referring to "transmission, distribution,

delivery, sale and trade in electricity." This license, as applied to all the activities specified in

it, was extended to January 1, 2011. It should be noted that the Company did not receive a new

and separate license for the distribution activity. Therefore, the activity is performed in

accordance with the provisions of the aforementioned overall license (that referred to several

activities). For details of these aspects of the Company's activity and the different limitations,

see sections 1.7.3, 1.7.5 in this report.

2.3.1.4. Trends and Changes in the Field of Operation and its Profitability

The Company estimates that several factors may affect the volume of operation and

profitability of this segment, such as changes in electricity consumption and changes in

electricity rates.

2.3.1.5. Critical Success Factors of the Field of Operation and Changes thereto

The Company estimates that the business success of the distribution segment depends, inter alia

on the demand for electricity level, the maintenance and operation costs of the distribution

facilities, the recognition of the total costs required to distribute electricity in the electricity rate

and in the ability of the distribution segment to be more efficient from both structural and

technological aspects.


As explained above, the Company operates as one integrated, coordinated system, to supply

electricity to consumers, from the stage of generation at production sites, through transmission and

transformation, to the end points of distribution and supply in the premises of each consumer of

electricity. The Company also connects customer premises to the grid and enlarges existing

connections.


a. Future Electricity rate – the Distribution segment

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In its document for a hearing, published on July 30, 2008, the Electricity Authority stated that

the document for a hearing is one stage for setting recognized costs for all the segments in the

electricity chain (generation, transmission, distribution and delivery), scheduled to be

performed during 2009.

In its decision of December 18, 2005 the Electricity Authority stated that in determining a new

rate base for the distribution segment it will establish a costs outline that will limit the

permitted annual investments level to maintain the standard of services to the consumer,

including reliable supply and connection to the grid.

To define the quantitative models that will assist the Electricity Authority to determine the

recognized costs for the distribution segment, the Electricity Authority appointed a consultant,

to study the distribution system development models proposed by the Company and by the

Electricity Authority and recommend the suitable models, in his opinion to the Electricity

Authority. As of the date of this report, the consultant submitted a final version of the models

and the Company is studying these models and the derived implications

b) Revenues

The net revenues from electricity sales attributed to the distribution segment in 2009 (according to the assumptions specified in note 38 to the financial statements), amounted to some NIS 2,621 million, compared to about NIS 2,697 million in 2008, a decrease in revenues of NIS 76 million.

c) Profit from regular activities - distribution segment

Profit from regular activities of the distribution segment in 2009 amounted to about NIS 405 million, compared to about NIS 396 in 2008, an increase of about NIS 9 million.

2.3.4 Competition

At the time of signing this report, the Company has no competitors in the distribution and supply

segment, except in relation to customers for bulk electricity who distribute the electricity to end

consumers (see section 3.3 of this report). Regarding the provisions of the Electricity Sector Law on

restrictions on holding licenses, see section 1.7.3 of this report.

Regarding the competition in the supply segment, the Company faces minor competition from

private producers who sell electricity directly to end consumers. In addition, in view of the

structural changes required by the Electricity Sector Law, including incorporation of the holders of

distribution licenses as separate companies (see sections 1.7.1 and 1.7.3 of this report), the Company

cannot estimate the implications of such incorporation for the future of the Company’s competition,

activity, profitability and financial situation.

2.3.5 Distribution capacity

On December 31, 2009 the distribution system included 24,946 km. of high voltage grid lines

(compared to 24,765 km. on December 31, 2008 and 24,118 km in 2007), 45,544 distribution

transformers with a total capacity of 21,522 MVA (compared to 44,954 distribution transformers at

December 31, 2008 with a total capacity of 21,185 MVA and 44.613 distribution transformers at 31

December 2007, with a total capacity of 20,976 MVA), and 19,259 km of low voltage grid lines

(compared to 19,131 km. on December 31, 2008and 18,415 km on December 31, 2007).

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The following table shows the number of distribution transformers by type on December 31 in the

years 2009 to 2007.

Number of transformers

Type of transformer:

Year:

12.6-6.3 MVA

22 MVA 33 MVA Total

2009 2,645 38,844 4,046 45,544

2008 2,614 38,358 3,982 44,954

2007 2,613 38,093 3,907 44,613

2.3.6 Fixed assets and facilities

Details of fixed assets and facilities described below refer to property and assets held by the

Company and/or used by the Company, in this field of operation ignoring any disputes between the

Company and the State regarding the Company’s rights to such property and assets which were held

by the Company when the concession expired. (Regarding the assets arrangement and its

implications for the Company, see section 1.7.2 in this report.)

The Company has about 30 regional and district offices, of which 25 are in separate sites and 5 are

integrated within secondary station sites, covering about 150,000 sq.m.

There are some 11,800 transformation, switching and accumulator rooms deployed all over the

country.

The Company owns these assets (see also section 1(g) in the Financial Statements on the assets

arrangement), or holds the assets and part of the lands are under long term leasing agreements

(mainly with the Israel Lands Administration) or under rights granted to the Company by property

owners (e.g., easement or permission to use free of charge which is not a lease, or holding rights

under a process to regulate it in a contract), or under rights granted to the Company by the law. The

aforesaid assets and rights are subject to floating liens created by the Company to secure its

obligations (see Note 18 e to the financial statements).

The Company’s property also includes property, mainly grids and lines, located in Judea and

Samaria and the Gaza area (including areas of the Palestinian Authority) (hereinafter: “the

territories”). Company management estimate that the use of these facilities for the supply of

electricity will continue, and the properties will remain in the Company’s possession, excluding

rights to use land connected to this land in the Gaza and northern Samaria Districts, from which

Israelis were evacuated in accordance with the Implementation of the Disengagement Plan Law,

2005. See also Note 11 (g) to the financial statements.

2.3.7 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

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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.

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.

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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.

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.

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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.

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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.

2.3.8 Intangible Assets

On the matter of the Company’s transmission license which includes the distribution license, and the

provisions of the Electricity Sector Law on granting distribution licenses, see sections 1.7.1 and

1.7.3 of this report.


As on December 31, 2009, the distribution segment has 3,410 permanent employees and 908

temporary employees. As explained above, some of these employees who are organizationally

attached to the distribution segment are engaged, in addition to setting up and maintaining the

distribution system, also in setting up and operating transmission grids (see section 2.2.8 of this

report). (See Appendix C below.) For details on terms of employment, training and other details,

see section 3.7 of this report.

2.3.10 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

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(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.

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

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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.

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

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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, see section ___ of this report.

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.

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

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body. The Company is working to plan new facilities so as to avoid deviations from the

aforesaid threshold.

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.

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2.3.11 Restrictions and regulation of Company activity

Criteria for supply reliability - rules for supplyi ng electricity to consumers

According to the Electricity Sector Law, one of the functions of the Electricity Authority is “setting

criteria for the standard, nature and quality of the service provided by the holder of an essential

service provider’s license”. The criteria include both rules for the agreement between consumers

and the Company, and the rates charged for the various services provided by the Company.

The criteria are updated by the Electricity Authority from time to time, and currently replace most of

the provisions of the arrangement that existed with rules for supply of electricity to consumers and

rules for connections.

In addition, the Electricity Authority defined the standard of reliability that underlies the electricity

rate, as follows:

a) The rate bases are intended to achieve an overall level of reliability for consumers of low

voltage electricity equal to an average of 100 minutes of power cuts per consumer per year

(hereinafter: “the target”).

b) (1) By February 2003, the Authority will define a binding plan to achieve the target (by the

date of signing this report, no such plan had been defined).

(2) The Authority will not recognize investments in the D.M.S. project (a Company project

intended to improve the reliability of electricity) outside the framework of the aforesaid

plan, to be approved by it.

c) On the basis of the existing operating setup, the Company is required to limit the difference

between levels of reliability in the different administrative districts and the general average

from 100% to 50%.

The Company estimates that the changes in the criteria as published in the rate document,

compared to the rules of supply included in the previous arrangement, have no significant

implications for the Company. It estimates that it is complying with these criteria, except as

specified above and below on the matter of setting a standard for reliability of supply. With

respect to the aforesaid standard of reliability, the Authority has not yet defined a binding plan

for achieving the target.

The Company has acted in the past to persuade the Electricity Authority to accept its position

that it will not be possible to implement the Authority’s decision, but it will be possible to

achieve an overall standard of reliability for low voltage consumers of about 141 minutes of

power cuts per consumer per year on average on completion of the whole D.M.S. project,

including its options (which according to the current timetable is expected to be finished

towards 2011). The Company achieved this target in 2009 and assumes that it will achieve this

target in years where the weather is average. Regarding the variance between the regions, the

Company succeeded in reducing the variance (standard deviation) between the criteria of non-

supply minutes of the administrative regions to a national average of less than 50% in 2005.

The Company cannot estimate whether its plan will be accepted by the Electricity Authority, or

the implications for it of failing to meet the target set by the Authority as stated above, although

it is possible that failure to meet the target on the dates stipulated by the Electricity Authority

could result in non recognition of certain costs in the distribution segment.

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On the matter of legal proceedings related to this field of operation, see section 2.3.10 of this report

and Note 24 b to the financial statements.

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3. Description of the Company’s business - matters pertaining Company activity in general

In addition to the aforementioned information, relating to each operation segment of the Company

separately, the following is a description of matters relating to the operation of the Company as a

whole. The information in this chapter, together with the aforementioned information, reflects the

general description of the business of the Company on a consolidated basis.

3.1 Information on Business Initiative

The business initiation and development unit, established in 1995, is responsible for business

initiation and development within the Company's fields of operation, in Israel and abroad, with the

purpose of expanding the operation fields of the Company and achieve optimal utilization of the

professional knowledge, the skilled human resource, the by products, infrastructures and its other

resources. The operation principles, activities and objectives of the unit are approved from time to

time through discussions of the Company's Board of Directors or its committees.

The Company acts in business initiation under the licenses of the Company, where some of the

activities require approval of the Electricity Administration Manager and were approved

continuously. At the date of this report, the unit acts in several primary fields:

a. Commercialization of by products produced during electricity generation. Forecast turnover for

2010 totals to approximately NIS 26 million.

b. Use of Company infrastructures to sell services. Forecast turnover for 2010 totals to

approximately NIS 31 million

c. Sales of knowledge, consultation and engineering services. Forecast turnover for 2010 totals to

approximately NIS 38 million. In addition the Company intends to act in a new field of energy

efficiency, where the Company intends to act through financing and/or sale of services against

a fee to organizations on energy saving. Forecast turnover for the first year of operation, 2010,

totals to approximately NIS 1 million.

d. An additional field, in which the Company does not act as yet is the communication field.

e. Technological Hot House - see section 3.6 b in this report.

Similar to other electricity companies, the Company has a significant advantage, arising from

the existence of a developed communication infrastructure, that may be used for selling

services on a business basis. This infrastructure is comprised of an optical fibers network on the

high and ultra high voltage lines. This infrastructure was built by the Company as part of the

electricity generation and transmission control system. This system has surplus capacity arising

from technological developments. In addition, the Company has thousands of pylons that may

serve as a basis for rapid spreading of a fibers network and as a basis for wireless antennas

system.

It was recently announced that the Minister of National Infrastructures granted a license to the

Company to conduct a test of the aforementioned action (provide a communication

infrastructure). The test will be conducted in Kiryat Shmone at homes of 150 families. Upon

completion of the test, decision will be reached on continues implementation of the project

throughout Israel.

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On December 13, 2007, the Company's Board of directors reached the following decisions

regarding the founding of four subsidiaries:

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

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

3. Detailed proposed decisions regarding the establishment of the companies will be brought before the Company's Board of Directors, including contractual contexts, articles of association, officers and required approvals. The workers' association has announced that it opposes the establishment of the subsidiaries and has forbidden all the employees to cooperate in drafting summaries and producing any information with this respect.

On June 2, 2008, the Company received a letter demanding data from the Restrictive Trade

Authority. In its letter, the Restrictive Trade Authority claimed that it learned from the newspapers

on the founding of a unit for cooperation with private producers in the Company. The Restrictive

Trade Authority claimed that the existence of the unit was not brought to the attention of the

Restrictive Trade Authority and subsequently the Company did not seek and did not receive the

opinion of the Restrictive Trade Commissioner on the permitted and forbidden actions in relations

of the Company with other parties that act or consider entry to the electricity generation sector. The

Restrictive Trade Authority demanded to receive data, documents and information on the actions of

the Company in that activity. The Company submitted numerous documents to the Restrictive Trade

Authority and attended meetings with the Restrictive Trade Authority to present and discuss this

subject.

On February 3, 2009, the Restrictive Trade Authority notified the Company that it will not insist that

the Company submit requests for exemption regarding six enterprises to which the Company wished

to provide services to private electricity producers and will not regard them as forbidden agreements

in restraint of trade, in light of the type of services that the Company is expected to provide to the

private electricity producers (provide building, consulting, planning and building supervision of

power station and commissioning of power stations and procurement services) and considering the

limited capacity generated in excess of the capacity needed for consumption of these producers and

since the Company will be excluded from the operation or management of these facilities after

construction is completed. In addition, the letter related to arrangements in which the Company may

have rights in the competing third parties or parties that may compete with the Company or grant an

option for shares in such third parties and specified the obligation of the Company to notify the

Restrictive Trade Authority in advance about such arrangements.

3.2 Insurance and risk management

a. Introduction

The Company has considerable properties and conducts extensive operations throughout Israel.

The Company, as other organizations, is exposed to risks that may affect its ability to achieve

goals and objectives set by the Company's management. These risks include, strategic,

operational, capital market (financial), natural and war risks. To reduce the probability of these

risks to the optimal minimum and to fulfill the requirements of the Electricity Sector

Regulations, the Company performs risks management actions, through risks reviews and cost -

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benefit analyses in the organizational units of the Company, including preparation of annual

work plans, timetables and required budgets and at the Enterprise Risk Management (ERM)

level, by an external consultant, according to principles outlined in the circular published by the

Government Companies Authority 2009-1. These actions assist the Company's management to

scale the risks and define orders of priority for handling the risks and the work plan required to

reduce these risks.

Based on the aforementioned, the Company decides which risks should be insured so that it

buys insurance policies, such as insurance of property, liabilities, construction, position holders

responsibility, vehicles and marine insurance, intended to provide proper coverage of damages

that the Company, its employees and other third parties may incur. It should be noted that the

policies usually exclude damages arising from terror and war actions. These damages are

usually covered by a special fund, provided by the State of Israel for compensation of damages

arising from terror and war actions. The fund is subject to the Property and Compensation Fund

Law.

However, it is noted that a dispute between the Company and the property tax authorities on

payment for direct war damages is currently in legal proceedings.

b. The Main Insured Risks.

The main insured risks are as follows:

1. Physical damage to property.

2. Loss of income and increased fuel expenses.

3. Natural hazards.

4. Liabilities.

3. Insurance

The Company buys insurance policies that cover appropriate insurance coverage as follows:

1. "All risks" insurance policy to cover damages to the property of the Company (except the

electricity grid), including loss of income and increased fuel expenses cover. Cover limit

of this policy is $ 1 billion.

2. Liabilities insurance policy that includes cover of general third party liability, product

liability, professional liability, accidental contamination damage and employer liability.

Cover limit of this policy is $ 100 million.

3. Construction insurance policy of all risks to insure damages during the construction of

power stations. Cover limit of this policy is the value of the project.

4. Position holders insurance policy that covers the liability of position holders in the

Company. Cover limit of this policy is $ 300 million.

5. Marine third party liabilities insurance, covering fuels loading/ offloading operations of

the Company. Cover limit of this policy is $ 50 million.

6. Compulsory insurance and third party insurance of the vehicles fleet of the Company.

6. Additional insurance policies according to the needs of the Company.

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3.3 Customers - consumers of electricity

a) On December 31, 2009 the Company’s customers numbered about 2.5 million. In the period

between December 31, 2008 and December 31, 2009, the number of customers increased by

about 34,900. On December 31, 2008, the Company's customers numbered about 2.4 million.

Consumption of electricity in 2009 was about 48,947 millions kWh, a decrease of 1,213 million

kWh compared to 2008. From December 2008 to December 2009, electricity consumption

decreased by about 2.4%, from 50,160 million kWh to 48,947 million kWh. For details of peak

demand see section 2.1.6 in this report.

b) The Company classifies its customers into households, industry, public buildings and

commerce, bulk, water pumping and agriculture.

The following table shows consumption of electricity by type of customer in the years ending

on December 31, 2009 and December 31, 2008 (see note 28 to the Financial Statements):

Year ended December 31, 2009

(in kWh millions and percentages)

12/2009 % 12/2008 %

Domestic 15,117 30.9 15,201 30.3

Industrial 10,329 21.1 11,218 22.4

Public, commercial 15,624 31.9 15,499 30.9

Palestinian Authority 3,783 7.7 3,666 7.3

Water pumping 2,404 4.9 2,749 5.5

Agriculture 1,690 3.5 1,827 3.6

Total 48,947 100.0 50,160 100.0

As of December 31, 2009, the Company served about 2.2 million households, representing

nearly every household in the State of Israel compared to 2.1 million households as of

December 31, 2008.

c) In the year ending on December 31, 2009, domestic consumption decreased by about 0.6%,

relative to the same period in the previous year. Revenues in current prices (gross) from the sale

of electricity in the domestic sector in 2009 decreased by about 5.6%, relative to the previous

year, due to rates decrease and decreased consumption.

d) The public commercial sector includes electricity consumption by stores, shopping centers,

various businesses and authorities in the public sector, such as local authorities, government

ministries and schools. Electricity consumption in this sector increased in the period ended on

December 31, 2009 by about 0.8%, relative to the previous year, leading to a decrease in

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(gross) revenues from the sale of electricity in this sector in 2009 of about 4.4%, relative to the

previous year due to a rate decrease.

e) Electricity consumption in the industrial sector decreased by about 7.9% in the year ended on

December 31, 2009, relative to the previous year. (Gross) revenues in current prices from the

sale of electricity in the industrial sector decreased in 2009 by about 11.7%, relative to the

previous year, due to a decrease in the rate.

f) Water pumping is required to provide all parts of the country with water for drinking, irrigation

and other purposes. In 2009, (gross) revenues in current prices from the sale of electricity in

the water pumping sector decreased by about 6.4% relative to the previous year, due to rate

decrease and decreased consumption.

g) In the year ended on December 31, 2009, electricity consumption in the agricultural sector

decreased by about 7.5%, relative to the previous year. Revenues decreased in 2009 by about

11.9% relative to the previous year.

h) Types of electricity rates:

There are five types of electricity rates to the consumer: “domestic”/ “agricultural”, “street

lighting”, “general”, “bulk” (that is - one meter for a main customer who provides electricity to

secondary customers) and rates based on load and time of consumption (hereinafter: “LTR”).

LTR rates were first introduced into Israel in 1982, and they now apply to very high voltage,

high voltage and low voltage customers whose connection size is 3x200 amperes or more, or

whose annual consumption is greater than 60,000 kWh. The rate is based on the marginal costs

in the system and is intended to strengthen the link between the costs the consumer causes in

the system according to the timing of consumption, and the amounts paid. Until April 2004, the

minimum size of consumption for application of the LTR rate was 100,000 kWh per annum.

This was changed by the Electricity Authority, further to its trend of extending the application

of this rate. In the Company’s estimation, the transfer of additional large consumers to the LTR

rate as a result of the aforesaid reduction in the threshold, which actually began in April 2005,

is not expected to have a material effect on the Company’s revenues.

The total number of consumers on LTR at December 31, 2009 was 53,678 (compared to 49,545

at December 31, 2008), representing only 2.2% of consumers, but who account for 58.1% of

total electricity consumption.

3.4 Marketing and distribution

The Company initiates advertising campaigns to improve its image through different media

channels. As of December 31, 2009, advertising costs of the Company totaled approximately NIS

7.3 million, compared to approximately NIS 11.8 million in 2008.

3.5 Seasonality

Demand for electricity in Israel is seasonal. The highest levels of demand are in summer (due to the

use of air conditioners) and in winter (due to the use of heaters) compared to transitional seasons. Not

only is average demand higher in winter and summer, but the days of extreme heat or cold are also

responsible for periods of peak demand.

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Company income in the different seasons is also affected by changes in the rates for consumers who

pay according to load and time (LTR), who represent about 58.1% of total consumption, since the

LTR rates are higher on average in summer than in the transitional seasons. In this context, the four

seasons are defined summer (July to September), winter (December to March), and the transitional

seasons - spring (April to June) and fall (October to November).

Gross revenues from electricity in 2009, 2008

Adjusted for the New Shekel of December 2009

In NIS millions

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total

2009 5,136 4,297 5,260 3,777 18,470

2008 5,587 7,246 5,499 5,668 24,000

3.6 Research and development

a. General

The purpose of the R&D expense is to develop tools to utilize and derive the greatest advantage

from new technologies, to deal with stricter requirements for environmental protection (in all

areas) and to achieve supply reliability targets, while striving to minimize costs. The results of

the investments in R&D are tested in advanced research projects, mainly on the following

subjects:

• New technologies to improve utilization in the electricity chain.

• Improving the reliability and quality of electricity supply.

• Load management (DSM).

• Varying sources of energy and renewable energies

• Environmental aspects relating to Company activity.

• Optimal utilization of land reserves and other Company resources.

• Improved and more efficient processes.

• Smart grid

The Company is favorably disposed to research with a potential for implementation within a

five year period. Projects are carried out either by Company employees or by external bodies

(universities, research institutions organizations and so on). It should be noted that not every

research project can promise success and implementation, however, the knowledge and tools

acquired during the research process are an added value that the Company can utilize in the

course of its regular engineering and operating work. Moreover, in every arrangement it makes

concerning research, the Company includes a clause that secures its rights to the outcomes (at

the cost of the research expenses and/or return on investment and/or royalties, as applicable).

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In 2009 Company expenses for R&D projects were approximately NIS 5 million (compared to

NIS 5 million in 2008). The operating budget for 2010 indicates that the Company is expected

to expend approximately NIS 18 million for research and development (excluding the

Technological Ideas Promotion Unit).

b. Technological Hot House

The Company is acting to build a technological ideas promotion unit that will be an

organizational unit in the Company for identifying ideas in the field of energy (including green

energy) that have a business potential.

The following subjects will be given priority in the screening process:

Treatment of hot house gases.

Reduction of electromagnetic fields.

Increased energy flow in ultra and high voltage lines

Decrease energy losses – Smart grid.

Persons with ideas, enterprises and inventors who will join the technological ideas promotion

unit for a period of two years will be granted financial support, accompaniment of a

professional team, use of Company infrastructures and connections in Israel and abroad. The

request for proposals process on the Internet received about 250 proposals up to the end of

2009. The selection committee submitted a recommendation to the investments committee,

headed by the CEO, to receive about ten projects for the technological ideas promotion unit.

Negotiations with the enterprising companies were opened concurrently.

The budget for 2010 includes a sum of approximately NIS 8.7 million as an initial estimate for

financing the unit and the chosen projects.

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3.7 Human resources (see Annexes E, F and G below)

3.7.1 Workforce by sphere of activity

a. The workforce on December 31, 2009 consisted of 12,663 employees compared to 12,004 on

December 31, 2008. About 40% of Company employees are engaged in development of the

electricity sector in the various segments.

Workforce by main areas of activity

Area of activity No. of positions

1) Generation 2,479

2) Transmission and transforming (including system management) 445

3) Distribution (marketing and districts) *4,318

4) Headquarters (strategic resources, finance and economics, general administration)

1,555

5) Service (organization, logistics, security and emergency situations, supply and storage)

1,767

6) Engineering projects (planning and execution) **2,099

Total: 12,663

* Includes employees engaged in setting the distribution system and transmission lines.

** Engaged mainly in setting up power stations, sub stations and switching stations.

b. Main changes in the workforce

In 2009 the Company increased its workforce by about 659 positions (5.5%) compared to December 31, 2008, mostly in the field of electricity sector development (assimilation of employees for building new generation facilities).

c. Significant dependence on a particular employee

The Electricity Corporation is not significantly dependent on any specific employee.

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3.7.2 Instruction and Training in the Company

a. Employee promotion and training course

Employees are promoted on a professional basis, with reference to their contribution to the Company’s productivity and the application of values of striving for excellence and continual update of performance norms, in line with changes in the technological, organizational and business environment in which the Company operates, and using tools for measurement and assessment.

Promotion to management grades involves strict appointment processes, which seek to comply with the CEO’s policy of promoting women to senior positions and strengthening managers at all levels, emphasizing excellence.

Active employees promotion – grade promotion in accordance with section 103 of the labor law takes place once every year/ two years, unless grade promotion is prevented in coordination with the workers committee.

Appointment to positions up to the level of a deputy division manager follows the procedure of the Company by a bi-partisan tenders committee, in which the human resources division manager has the decisive vote in the event of a dispute among the tenders committee members (in tenders up to a deputy department manager level and up) and the CEO (in tenders for department manager position and up).

The Company provides both vocational and managerial promotion paths, which are integrated into the human resources development system which is based on internal training in the various areas of work, as well as programs for acquiring or completing formal education. This is all part of a continuous process of nurturing human resources and threshold requirements for professional/ managerial advancement in the transition between positions.

The Company emphasized the need to expand occupation fields and specializations of employees and managers. Consequently, the Company promotes plans for internal mobility and professional retraining, including rotation of managers and holders of sensitive positions, aiming to utilize the potential of the existing human resources prior to initiating external recruiting and assimilation processes.

b. The training arrangements in the Company include five schools and a national training headquarters:

• School for electricity generation and transmission professions - This school mainly trains

employees of power stations and transforming and switching stations, as well as

employees of the national unit for load management. The school runs courses and

supplementary training on integrating new technologies, such as electricity generation with

natural gas and in combined cycles, operation and maintenance of transforming and

switching stations, operating control systems in power stations using programmed

controllers, and refreshing the knowledge of employees in the division..

• School for marketing and grid professions - This school trains the district workers on

matters of marketing and service, and areas of work on the grid. This includes training on

service and marketing for staff at the Company’s call center on 103, strategic customer

coordinators, workers in the commercial accounts and collection departments, and so on.

The school also trains field staff to the level of experienced technician and practical

engineers..

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• School for engineering projects - This school trains employees and managers in the

engineering projects division, which includes the engineering planning department and the

project execution department, plus the logistics and property department and the

technology planning and development department..

• School for computers and information technologies - The school trains all Company

employees for all types of computer usage and assimilation of computer technologies, and

also trains employees of the IT department on computer systems and telecommunications..

• School for management and administration - This school trains and develops management

staff in the Company at all levels and provides training for managers on matters of

business, management and administration. This includes training employees for

department and division management positions as well as head office administrative staff.

The Company’s training organization is intended to provide support for improving the performance of employees and raising the professional standard of the Company’s human resources. The system provides training in a whole range of trades covering the Company’s main areas of activity, plus the qualifications required by law and regulations for work in certain areas. The training staff develop study and training programs for employees and managers at different stages of their professional lives in the Company, and preparation for moving into different fields of work. Training also focuses on incorporating new technologies. All courses are managed by training teams from the various schools and other Company employees who share their knowledge with course participants. The training system also handles formal study arrangements, for example for technicians and engineers, in subjects required by the Company, particularly in areas of new technologies, as well as studies for a master’s degree in business subjects. The training organization operates continuously to maintain its status as an authorizing entity wherever Company employees require such authorization and the authorization is subject to participating in courses and fulfilling their requirements. The training organization also acts to expand the number of study syllabuses approved by the Ministry of Industry and Trade and also curriculum and study requirements recognized by the Ministry of Education, the Advanced Studies Pay Committee, Adults Education Department.

c. Costs with respect to training and studies on the Company

Following are expenses arising from training and studies in the Company in 2009. There is no material change in these expenses compared to 2008:

1. School expenses in 2009 (lecturers, refreshments, equipment, travel for participants)

totaled NIS 7.8 million.

2. Costs for AMA supplementary training for employees and managers - NIS 13 million.

3. Payment for courses, seminars and conferences outside the Company - NIS 2.4 million.

4. This does not include direct and associated costs of studies for higher degrees and

students for diplomas who are recorded on account of their salaries and are taxed.

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3.7.3 Compensation funds for employees, benefits and employment agreements

a) Employment agreements

1) Labor relations in the Company are regulated, in addition to arrangements in labor

legislation, by work agreements and collective agreements (the new labor constitution

and Company procedures dealing with work conditions (hereinafter “the Employment

Agreements”), which constitute a binding format in the Company for matters of starting

or terminating employment, working conditions, labor relations and the rights and duties

of the parties.

The labor agreements apply to all employees in the Company (except those on personal contracts), with the reservations that they include.

The labor agreements (and particularly the labor constitution and Company procedures) regulate most terms of employment in the Company, including: salary and terms of service, eligibility for an energy basket, hours of work and rest, overtime, shift work, paid absences (vacation, sickness and so on), retirement terms and more.

The labor agreements also include various provisions concerning personnel management in the Company, including: procedures for receiving new employees and dismissing employees (including restrictions on the reasons for which an employee may be dismissed, the manner of carrying out the dismissal and the circumstances in which there is need to obtain the consent of the workers’ committee on this matter), restrictions on moving employees from one job to another, disciplinary arrangements and so on. The labor agreements are changed and updated every few years. Pay agreements are reached following negotiations between the Company management and the General Federation of Labor (the Histadrut) and the National Committee of IEC Employees, and require the approval of the Government Companies Authority, the Wages and Work Agreement Officer in the Ministry of Finance and the Company’s Board of Directors. The latest pay agreement (for 2006 -2009) was signed on June 24, 2008.. In principle, Company employees can be divided into two groups - management grades and professional grades - engineers, academics, lawyers, practical engineers and technicians. The wages scale of these employees grades is similar. The Company maintains one pay table, where for each management grade there is an equivalent professional grade. Pay terms, pension and other employee rights relating to the termination of the employer employee relationship vary for the different groups to which the employees belong, as described in section 3 below.

2) The Company is subject to section 29 of the Budget Fundamentals Law, which in fact

restricts its ability to operate independently in matters of employee pay and benefits, and

places on it an obligation to obtain the approval of the Government Companies Authority

and the Wages and Work Agreements Officer in the Ministry of Finance on such matters,

in addition to the approval of the Government Companies Authority, as stipulated by the

Government Companies Law.

On August 21, 2006, the Company received a letter from the Supervisor of Wages and

Work Agreements, announcing the decision regarding the salary terms of the Company's

employees and pensioners specifying among others, several salary components that were

paid to Company employees and pensioners, contrary to the Budget Basis Law – 1985,

which he therefore decided to cancel and/or change. The Supervisor of Wages and Work

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Agreements also instructed the Company to require its employees and pensioners to

refund these components. The Supervisor of Wages and Work Agreements also decided

that Company pensioners will be promoted to a higher rank every three years instead of

every two years.

On October 3, 2006, the Supervisor of Wages and Work Agreements sent another letter

to the Company, instructing the Company, inter alia, to immediately stop/ change the

aforementioned payments paid to part of the senior employees and pensioners ("The

Seniors Group"). The Supervisor of Wages and Work Agreements consented to hold a

supplementary discussion on the remaining salary components to enable implementation

thereof at a later stage.

Following sanctions by the employees on the implementation of the decision and a court

hearing in the Haifa District Labor Court on November 12, 2006, the Histadrut, the

Employees organization, the Company and the Supervisor of Wages and Work

Agreements reached the following decisions:

- The employees will remove the sanctions and the Company will adopt the Supervisor's decision regarding the group of senior employees.

- For a period of one month, talks will be held regarding the Supervisor's decision as to salary excesses in the Company.

- Until the talks have been exhausted, the Company will not act to implement the decisions of the Supervisor of Wages and Work Agreements in the matter of filing retroactive refund claims.

The talks between the parties failed. On January 19, 2009, the Company received another letter from the Supervisor of Wages

and Work Agreements, indicating his intention to exhaust the negotiations before issuing an order to implement the aforementioned decisions (regarding subjects not yet implemented). The Company was also requested to present its position on the results of the investigation recently conducted by the Supervisor, showing that promotion of pensioners every three years is an apparent deviation in wages. In conclusion, the letter stated that the Supervisor of Wages and Work Agreements intends to conduct a comprehensive audit of condition of wages paid to employees and pensioners of the Company.

On January 26, 2009, the Company answered the letters of the Supervisor of Wages and Work Agreements in a detailed letter, expressing its opinion that the discussed wage components are paid in accordance with the law. Pursuant to this letter, the parties opened discussions on the subject.

On June 10, 2009, the Supervisor of Wages and Work Agreements notified the Company of his decision, that requires the Company to implement the decision of August 21, 2006 and all its components (except the vehicle expenses refunding section, on which it was not yet decided to apply the decision), including a claim for repayment of additions to wages defined as contrary to the law and paid to employees and pensioners from January 1, 2004 and up to the decision implementation date. On June 11, 2009, the Company addressed the Supervisor of Wages and Work Agreements with a request to delay the implementation of his decision, at least for the period that will enable progress in the negotiations to implement the reform in the Company and in the Electricity Sector and the efficiency and restructuring processes required by the Company. On August 6, 2009 a special collective agreement was entered between the Company and the Histadrut and the Company's employees committee, approved by the Supervisor of Wages and Work Agreements in the Ministry of Finance. According to the new collective agreement, the parties will conduct discussions up to January 1, 2010, on the decision of the Supervisor of Wages of June 10, 2009.

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The discussions will include, inter alia, the issue of transition of the budgetary pension arrangement to a mechanism of linking the pension to the CPI and/or offsetting from agreements/arrangements and/or any other arrangement. The balance of the addition to wages payable to Company employees on December 2009, according to a special collective agreement dated June 24, 2008, will include a complement of up to 4.7% only, instead of 5% and cancellation of the labor dispute, unless the Supervisor of Wages and Work Agreements orders in writing to implement any part of his decisions on a date that will not be earlier than January 1, 2010. In the mean time, the Supervisor of Wages and Work Agreements notified the Company and the Histadrut that the implementation of his decisions will be postponed up to January 1, 2010 at least.

On January 12, 2010, a senior deputy of the Supervisor of Wages and Work Agreements notified the Company that since the differences between the parties, as expressed during the talks are material and cannot be resolved, the Company must make preparations to implement the decisions of the Supervisor of Wages and Work Agreements, as of the salary of January 2010 (if he chooses to order the implementation).

On February 3, 2010, the Supervisor of Wages and Work Agreements in the Ministry of Finance instructed the Company to implement his decisions, which were already implemented by the Company and also correct the deviations in salaries (an star rank to an employee with 20 years tenure and an employee with 25 years tenure, 14th month salary and pensioners promotion in rank) specified in the decision and require employees and pensioners who received deviating additions to salaries to refund amounts paid to them from January 1, 2004 and up to the decision implementation date.

The Supervisor of Wages and Work Agreements also announced that before reaching a decision on the "vehicle expenses refund" item, he must receive the response of the Board of Directors on the subject within 40 days, with a comparison the vehicle expenses refund of State employees, whereas the Company must submit its response on the subject of retirement rank to rank A employees within 30 days,

In light of the understanding between the parties after accelerated negotiations, and the emerging collective agreement on the subject the Supervisor of Wages and Work Agreements approved in writing to refrain from implementing his decisions in the salaries of February 2010 and March 2010.

Draft of the Main Principles of the Proposed Collective Agreement: 1. Starting on January 1, 2020, the pension will cease to be linked to changes entered in the

salary of an active employee at any time or changes in the salary of all Company employees and will be updated in January of every year for the pension of January and of subsequent months, at the increase rate of the CPI in the past year.

2. Employees who retired to pension up to December 31, 2009 inclusive, will be compensated with respect to the transition to linking pensions to the CPI in the following method: - A pensioner whose rank on December 31, 2009 was the highest rank (rank 27/46 and

up) in the salaries scale, will receive compensation at an 8% rate of the determining pension.

- A pensioner whose rank on December 31, 2009 was not the highest rank in the salaries scale, will receive compensation at a 12% rate of the determining pension.

3. Pensioners ranks that were valid on the eve of signing this agreement will not be changed.

4. Agreements and arrangements in the Company relating to the 14th month salary and its payment mode will continue to apply to employees and pensioners who joined the Company before January 1, 2004, as applied on the eve of signing this agreement and will be approved in accordance with section 29(a) of the Budget Bases Law by the Supervisor of Wages and Work Agreements.

5. The Company will not require and will not claim a refund from employees and pensioners regarding salary items specified in the letter of the Supervisor of Wages and Work Agreements of August 21, 2006.

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6. In the event that an increase in wages for 2009 is determined under a national agreement, exceeding 0.5% (half percent) the active employees of the Company will receive the increase in wages for 2009, less 0.5%.

7. Starting on January 1, 2010, The Company will allocate, once a year, for the welfare of each employee who retires to pension and for every kin who is entitled to pension with respect to a deceased employee/ pensioner, a total sum to be calculated as follows: A sum of NIS 393 per year per each pensioner. Payment for 2010 will be updated according to the change rate between the CPI for December 2007 and the CPI for December 2009. Starting on the fiscal year 2011 and in every subsequent year, the sum will be updated according to the change rate between the CPI of the last December preceding the update (published on January 15) and the CPI for December of the previous year (published on January 15 of the previous year.

8. Employees who started to work in the Company from January 1, 2004 and up will not be entitled to a 14th month salary and to a Star rank. The parties will convene a joint steering team to review the increase of the provisions made by the Company to a cumulative pension for employees who started to work in the Company from January 1, 2004, by increasing the current provisions rate made to the cumulative pension and/or through including additional salary items and/or an additional share of current salary items.

3) Company employees are divided into several main groups:

- Permanent Employees, 9,689 employees as of the salary of December 31, 2009:

An employee who has received tenure pursuant to Company procedures. These employees are divided into generations A and B (employees, who started work in the Company up to June 10, 1996 inclusive) who have a budgeted pension pursuant to the regulations of the Central Pension Provident Fund of the Electric Corporation Employees (managed by C.P.Y.), and generation C employees (who began work from June 11, 1996 onwards), who are insured in accumulator external pension funds.

- Employee on special contract (879 employees as of the salary of December 31, 2009): an employee who is hired for a temporary position, to perform a defined task that lasts for a defined period, such as: setting up a power station or sub stations or working on long term projects in the Districts. These employees are entitled, under the collective agreement, to the rights specified in the labor constitution for permanent employees, excluding entitlement to the budget pension and to reduced rate energy basket. Severance pay paid to employees on special contract who are subject to a special collective agreement since 1996, upon dismissal is increased by 200% for each of the first two years of work, and by 300% for each subsequent year.

According to collective agreements on the subject, the maximum period of employment of employees on a special contract who began work in the Company from January 1, 2005 onwards is 5 years, and the maximum period of employment for those who began work up to December 31, 2004 inclusive is up to 10 years.

- Temporary employee (872 employees as of the salary of December 31, 2009): An employee hired for a particular task but not on a special agreement. Temporary employees have the rights specified in the labor constitution, with the exceptions listed therein, and excluding the right to budgeted pension and energy basket. Severance pay paid to temporary employees is as required by law.

- Temporary employee on a special agreement (1,213 employees as of the salary of December 31, 2009): a temporary employee who has worked for at least two years in the

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Company and signed a transition to temporary status special agreement. As per the collective agreement, these employees are entitled to the rights specified in the labor constitution for permanent employees, excluding the right to budgeted pension and an energy basket. Severance pay paid to temporary employees on a special agreement is as required by law.

In accordance with the collective agreements on the subject, the maximum period of employment of temporary employees on a special agreement who began work in the Company from January 1, 2005 onwards is up to 5 years, and the maximum period of employment for those who began work up to December 31, 2004 inclusive, is 10 years, .

- Employee on personal contract (73 employees as of the salary of December 31, 2009): an employee who signs a personal contract on being accepted for work in the Company, which stipulates his salary and other terms of work.

b) Rewards for employees

In general, the Company has no special reward programs for employees, except for the following:

1) The Board of Directors may decide on payment of a bonus to employees with the

restrictions of the guidelines from the Government Companies Authority in this context,

which stipulate among other things that the bonus may not be more than 10% of the

Company’s net profit for the year. A bonus is intended to reward employees for

outstanding performance and the Company’s success, and must be approved in advance

by the Government Companies Authority.

2) Permanent employees and pensions are entitled to an energy basket up to a consumption

ceiling of 18,000 kWh per annum, for domestic consumption at their place of residence

for their personal use.

3) Central Pension Fund

As of March 8, 2005, the Company deposits funds to cover pension liabilities for pension

for employees of generations A and B in the Central Pensions Fund ("Pension Fund").

The Pension Fund acts by force of the Income Tax Regulations (Rules for Approving and

Managing Pension Funds) - 1964. The fund is currently managed by the managing

company ("CPY") in accordance with these regulations. See also Note 19 to the Financial

Statements.

3.7.4 Organizational Change – "Matzpen Plan"

On May 14, 2008, the Board of Directors of the Company approved in principle the outline of the plan for structural change (Matzpen Plan), presented to the Board of Directors by the CEO of the Company. The plan is based, inter alia, on the retirement of about 2,000 - 2,500 employees and a process of reducing the number of Company employees to be spread over a period of three years, reorganizing Company units, including a reduction in the control of the Management, consolidation of functions benefiting from economics of scale, elimination of duplications and creation of supportive management mechanisms aimed at improving processes, management flexibility and optimal utilization of resources and manpower. Initial estimates made by the Management of the Company indicate that the total cost of the plan is an estimated NIS 2.3 - 4.0 billion. Conditions for recognition of the amounts expected with respect

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to the plan (except employee retirement) in accordance with the instructions of IAS No. 19 have not reached fruition, as yet. The Board of Directors instructed the CEO of the Company to commence an intensive consultation and negotiation process, on the subject of workers’ rights with the workers’ representatives, as required by law, as soon as possible. The workers’ organization announced that it objects to the implementation of the plan and prohibited the workers from cooperating on this subject. Several consultation meetings were held later on but did not lead to an understanding between the parties. The Management and the workers' organization, agreed at the beginning of May 2009, to open discussions (as detailed in section 1.7.1 in this report) on the restructuring of the electricity sector and structural change and efficiency process in the Company and open negotiations on resulting workers rights, scheduled to be completed up to August 1, 2009, aiming to reach an agreement on the aforementioned changes. Representatives of the State, the Histadrt, the employees organization and the Company's management agreed on March 18, 2010 to start an intensive and continued process of discussions on the subject of the structural change and related employees rights. These discussions, attended by all parties, are scheduled to take place on several days each week, aiming to reach an agreement on the aforementioned subjects.

3.7.5 Labor relations and Employment Termination

Labor relations in the Company are based on the principles of the new labor constitution for

Company employees, entered into on March 25, 2002 ("Labor Constitution"). The Labor

Constitution and procedures derived from it are the main normative source for all matters related to

engagement to work in the Company, employment termination, work conditions and labor relations.

The labor constitution has a legal status of a bilateral collective agreement, valid until December 31,

2015.

Section 185 of the Labor Constitution states that according to Company needs the Company's

Management, upon agreement with the workers committee, may move an employee to a different

position or another work site, temporarily or permanently, without affecting the employees work

conditions and without deducting from the salary.

Employment termination of Company employees subjected to the Labor Constitution is regulated in

sections 200-201 of the Labor Constitution. The provisions of these sections enable the Company to

dismiss an employee due to re-organization in the units of the Company or due to any other justified

reason, where in every case of dismissal, except a temporary employee, the Company will first

discuss the case with the workers committee and the employee will be dismissed in agreement with

the workers committee.

In the absence of an agreement with the workers committee on dismissing a Company employee, the

issue will be brought to negotiations between the Company's CEO and the Histadrut, according to

the instruction of section 223 of the Labor Constitution. The Labor Constitution does not provide a

decision mechanism for the event of disagreement between the Company's CEO and the Histadrut.

The aforementioned provisions of the Labor Constitution indicate that the ability of the Company's

management to initiate efficiency actions involving employment termination of Company employees

is limited. Such steps require the consent of the workers committee and in the absence of such a

consent, the issue may be escalated to negotiations with the Histadrut. When such negotiations fail

the Labor Constitution does not provide a mechanism that will enable implementation of a re-

organization process involving dismissal of employees without obtaining the consent to these

processes.

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On the matter of labor relations in the Company and the status of labor disputes at the time of

signing this report, see Note 24(c) to the Financial Statements.

3.7.6 Labor Disputes

1) A notice with respect to a strike was submitted on May 26, 2008, according to the Settlements

of Labor Disputes Law. The disputed matters are:

The intention of the employer to implement a comprehensive organizational change and an

efficiency plan, with significant and critical impact on the employees in all aspects, including,

but not limited to work conditions, rights, pension rights, status, employment security. The

employer intends to perform a massive efficiency plan within the framework of the

organizational change and the efficiency plan, including, inter alia, early retirement of 2,000 up

to 2,500 tenured employees, from all units of the Company, up to three years from the plan's

commencing date, according to lists compiled by Management. The employer is not acting in

good faith when it attempts to push the workers organization aside and present it with

accomplished facts, by setting, inter alia, a nine months timetable for preparing and

implementing the organizational change and the efficiency plan.

On January 1, 2009, the CEO and the Employees Committee reached understandings on the

implementation of some of the steps of the Matzpen plan and conducting intensive negotiations

about subsequent steps, up to February 15, 2009. Because the negotiations failed, the CEO

announced on March 10, 2009, that implementation of the organizational restructuring

component of the Matzpen plan will continue.

Following the decision of the CEO, the employees opened rolling sanctions on March 12, 2009.

The Company appealed to the Electricity Authority to receive rate coverage for damages caused

by the sanctions.

In response to the Company's applications to the district labor court, the court issued the

following decisions:

The decision issued on April 5, 2009 obliges the employees to repair every failure and

cooperate with all actions required to prepare and submit the Financial Statements on time. The

decision forbids the employees from opening any sanctions that will disrupt the Financial

Statements preparation process. It also states that the Company will suspend actions to

implement the "Matzpen" plan for 45 days and orders all the parties to open intensive

negotiations on reviewing ways to implement the "Matzpen" plan by mutual consent. The

decision also states that until another decision is made, the Company will not deduct from the

wages of the employees with respect to sanctions up to that date. The decision made on April

16, 2009, obliges the employees to refrain from disruptions that may disrupt regular supply of

electricity, namely, enable routine operation of the electricity chain and repair all failures in any

of the Company's generation units. This obligation excludes renovation actions in second and

third shifts and connection of generation units to natural gas.

On April 26, 2009, after several hours of unsuccessful attempts to reach an agreed upon course

of understanding between representatives of the State, the workers organization and the

Company, another discussion was scheduled for May 3, 2009. On May 3, 2009, the

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Management and the workers organization reached understandings that will remain in force up

to August 1, 2009, or up to a later date, as agreed upon by the parties, relating mainly to the

suspension of the Matzpen plan and reverting the situation related to Matzpen plan to its status

on the eve of February 15, 2009, removing all sanctions and returning immediately to full

normal work routine.

A letter, delivered earlier, on April 30, 2009, from the Director General of the Ministry of

National Infrastructures and the Director General of the Government Companies Authority,

addressed to the CEO of the Company and to the Chairman of the workers organization,

announces their intention to conduct discussions on the restructuring of the Company with the

parties and negotiate the workers rights under the restructuring plan.

2) Pursuant to the decision of the Salaries Commissioner of June 10, 2009, on implementing the

decision of the Supervisor of Wages and Work Agreements of August 21, 2006 and all its

components (except the issue of refunding vehicle expenses, on which the Company was

requested to present the position of the Board of Directors), a notice of a strike was issued on

June 30, 2009 according to the Settlements of Labor Disputes Law. The disputed issues: a

demand to enter into a collective agreement to regulate all employees rights and terms of their

employment, in light to the decision of the Supervisor of Wages and Work Agreements at the

Ministry of Finance to reduce rights.

On August 6, 2009, a special collective agreement was signed, inter alia, stipulating talks on the

decision of the Salaries Commissioner of June 10, 2009, freezing payment of a 0.3% addition to

the salary in salary/pension of December 2009, and calling off the said labor dispute.

On February 3, 2010, the Supervisor of Wages and Work Agreements in the Ministry of

Finance instructed the Company to continue implementing his decision of August 21, 2006,

correct the other deviations from salaries, specified in his previous decisions, starting from the

salary of February 2010; require employees and pensioners to refund payments paid to them ,

contrary to his decisions, from January 1, 2004 and more.

Pursuant to intensive negotiations between the Company's management, the employees

organization, the Histadrt and representatives of the Ministry of Finance, the parties reached an

understanding on the implementation mode of the decisions of the Supervisor of Wages and

Work Agreements, offsetting from agreements and transition to linking the pensions to the CPI.

Negotiations are currently conducted in preparation for signing a collective agreement on these

subjects.

On February 21, 2010, the Supervisor of Wages and Work Agreements approved postponement

of implementing the instructions of his decisions to the salary of March 2010, in light of the

understandings reached by the parties (see details in section 3.7.3 a above).

3) On July 8, 2009, representatives of the State, the Company and the employees organization

reached an understanding on the subject of holding intensive discussions on the restructuring

and efficiency plan and conducting negotiations on the subject of employees rights in the

restructuring, aiming to reach agreed upon principles by September 18, 2009.

4) A notice of a strike was issued on November 12, 2009, according to the Settlements of Labor

Disputes Law.

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The main disputed issues:

a. Attempts to damage the pension of the employees, reduce the actuarial debt and decrease the

pension liability of the employer, including attempts to damage the Central Pension Provident

Fund (CPY) and its financial strength. The employer ignores demands of the employees’

representatives to improve pension terms and prevent pension erosion and tries to go back on

earlier agreements.

b. Demands of the employees’ representatives regarding implications and impact on work

conditions, salaries and status of employees of the Accounting and Economic Division, arising

from imposing an exceptional work load on these employees.

5) A notice of a strike was issued on January 28, 2010, according to the Settlements of Labor

Disputes Law. The dispute issue is the demand of the employees' representatives to enter a new

wages agreement for the period starting on January 1, 2010, after the period of the previous

wages agreement expired.

3.8 Fixed assets and facilities

a. General

The details of fixed assets and facilities given below refer to property and assets owned by the

Company and/or used by it, ignoring disputes between the Company and the State regarding the

Company’s rights to the said assets and facilities that were held by the Company at the time the

concessions expired. (For details of the “assets arrangement” and its implications for the

Company, see section 1.7.2 in this report.)

At the Company’s initiative, over the last few years there has been a concentrated, focused and

continuous effort to collect information on all the Company assets, that was dispersed in the

different divisions and districts, including transformation stations, mobile/ temporary/ leased

facilities etc., and to set up a proper “assets ledger”, for recording rights (including caveats,

where relevant), management and supervision, including removing intruders from Company

assets or settling the status of those using Company assets. The Company has a full “main

assets ledger” (that is updated from time to time) and a “secondary assets ledger” (about 13,000

assets, mainly transformation stations). The Company is also working to register its rights to

assets, both “main assets” and “secondary assets”.

b. Facilities serving all the operation segments

Below are details of fixed assets and facilities used in all segments of activity.

The Company’s head office building, with an area of 80,000 sq.m. is located at the southern

entrance to Haifa. The Company has leasing rights to about 79 properties used for various

purposes, such as offices, storerooms, monitoring stations, temporary and mobile sub stations,

etc.

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The Company also has 9 logistics sites used for storage, as follows:

Site name Location Type Area in sq.m.

1. Technical Center Workshop Tel Aviv Logistical 1,380

2. Giborei Yisrael Warehouse Tel Aviv Logistical 8,508

3. Kiryat Shmone Warehouse Kiryat Shmone Logistical 3,000

4. Kiryat Gat Site * Kiryat Gat Logistical 3,600

5. North Acre Logistics Center* Acre Logistical 121,572

6. Storage area for equipment carts Jerusalem Logistical 775

7. Beit Dagan Warehouse Beit Dagan Logistical 85,108

8. Leyland Logistical Center Ashdod Logistical 121,978

9. Orot Rabin Logistical Center Hadera Logistical 270,000

Total area: 615,921

* At the time of signing this report, these properties are vacant and not used for storage.

These assets are owned by the Company (but see note 1.g to the Financial Statements on the

assets arrangement) or held by it, in the framework of long term leases (mainly with the Israel

Land Administration) or of rights that were granted to the Company by the owners of the assets

(e.g., easement or permission to use free of charge which is not a lease, or possession right with

a process of arranging it under a contract) or rights granted to the Company by law. The

aforesaid assets and rights are subject to floating liens created by the Company to secure its

obligations (see note 18.e to the financial statements).

c. Fixed Assets

The fixed assets of the Company are divided into two main groups: Operated fixed assets and

fixed assets under construction. The operated fixed assets is mostly comprised of power

stations (including land, buildings and machines), switching and transformation stations,

distribution grids, switching stations and ultra high 400 kWh voltage lines. Fixed assets under

construction is mostly comprised of power stations and buildings.

The Company has assets (particularly distribution networks) in the Palestinian Authority areas.

Company management estimates that if ownership of these assets is transferred from the

Company, it will be compensated with an amount equal at least to the value of the assets as

shown in its financial reports (see note 11 g to the Financial Statements).

d. Intangible Assets

1. Software

The Company deals in characterizing, developing and implementing information systems

and solutions that support business processes of the Company in the following segments:

Customers service and billing, electricity chain, planning and erection of engineering

projects, security and safety software and software for administration, business and logistics.

The Company has acquired extensive experience and knowledge in planning, hosting and

operating computerization infrastructures on all types of platforms, telecommunication and

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control and command infrastructures and services (optical fibers, microwave, wireless),

specialized in various IT architecture and technologies, focusing mainly on data security and

integration as well as the whole life cycle of high volume computerization and

telecommunication projects.

2. Patents

As of December 31, 2009, the Company has two patents, due to expire during 2010 to 2012,

on the following subjects: a) a method to reduce an external magnetic field of an electrical

cable; b) Alum conductor for an electricity line.. The Company has two additional patents

under approval processes.

In addition, the Company handles patents of the Technological Ideas Promotion Unit. The

unit conducts patents applicability tests of patents in which the Company is interested,

budgeted in a separate budget, subject to the agreements procedure of the Company.

Moreover, the unit registers patents to protect ideas of the inventors in the hot house and the

payment for the registration process is defined as a loan.

3. Concessions

Jordan Investments Co. Ltd., ("Jordan Investments"), holds a user license in 20 VHF

frequencies which it purchased in 1999 from "Aeromid". The purchase of the frequencies was

financed by the Company and in return, the Company received exclusive user rights for these

frequencies. These frequencies are designated for use in the DMS project.

3.9 Working Capital

Credit policy

a. Customer credit: the average range of credit to customers in the year ending on December 31,

2009 was 61.6 days compared to 53 days in 2008. The average extent of customer credit in the

year ending on December 31, 2009 was approximately NIS 4,004 million compared to NIS

3,604 million in 2008.

b. Supplier credit: the average range of credit from suppliers in the year ending on December

31, 2009 was about 39 days compared to 46 days in 2008. The average extent of supplier credit

in the year ending on December 31, 2009 was approximately NIS 1,472 million compared to

NIS 1,633 in 2008.

3.10 Financing

3.10.1 The electricity rate is set on the basis of the Company’s costs as described in section __ of this

report and in note 1(c) to the Financial Statements. In view of the aforesaid rate principles, the

Company’s revenues (excluding yield on capital less the dividends required according to the

guidelines of the Companies Authority, as stated in section 1.8 of this report) do not constitute a

main source for funding the development of the electricity sector, and the Company is therefore

required to raise most of the funding necessary from external sources.

Nevertheless, in recent years, financing part of the development plans of the Company was raised

through an increase of rates. Thus for example, starting from September 8, 2007, the Electricity

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Authority approved an recognized cost addition of 5% for a year or until a new rate base is

determined for the generation segment, whichever is earlier, which is advance recognition of the

cost of the investment. Moreover, in its decision of October 30, 2008, the Electricity Authority

recognizes emergency plan financing costs in an accumulated amount of NIS 2 billion. The

recognition will be spread over a period of two years, starting on January 2009 and up to November

1, 2011 or until collection is completed..

The Company generally raises capital by issuing public and private debentures in Israel and abroad

and from local and overseas banks by means of credit lines and dedicated loans to fund imports and

equipment. The Company conducts hedging transactions from time to time, to minimize the effect of

fluctuations in the exchange rates of the currencies.

3.10.2 Average rate of interest on loans

The Company funds its activities with bank credit and non-bank credit. Below are details of average

rates of interest for the period ended on December 31, 2009 on loans that are not designated for

special use by the Company, split into short term and long term credit from bank and non-bank

sources.

Details Average interest rate (%) for short term credit

Average interest rate (%) for long term credit

Bank credit sources 3.31 5.13

Non bank credit sources 3.18 6.48

3.10.3 Restrictions applying to the Corporation on receiving credit

The Company will require quite large amounts of external financing to fund its development plan.

The Company’s ability to borrow from the Israeli banking system is limited due to the credit

restrictions applying pursuant to the Bank of Israel’s instructions for proper bank management.

According to these instructions, an Israeli bank may not grant a loan to a “single borrower” that is

greater than 15% of its shareholders’ equity, after adjustments, and in addition an Israeli bank may

not grant loans to a “group of borrowers” that amount to more than 30% of the bank’s shareholders’

equity, after adjustments. The term “group of borrowers” includes, inter alia, the borrower, the

party that controls the borrower and any other party controlled by them. Regarding these

restrictions, the State is not considered a borrower and is not included in a “group of borrowers”.

According to the Supervision of Financial Services Law (Provident Funds), 2005 and its regulations,

a fund may hold securities, make deposits and grant loans to a company for a maximum of 15% of

the estimated value of its assets. In addition, any fund may hold up to 15% (25% for groups of

investors) of the total face value of negotiable debentures of the same series. In effect, the Company

estimates that the provident funds are not exploiting the maximum rate allowed by the Law.

The theoretical potential of obtaining loans from the banking system and from the institutional

market in Israel is, in the Company’s estimation, considerably lower than its needs, and in any case

cannot constitute the main source of financing for its development plan.

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3.10.4 Credit received from the date of this report to the date of signing it

From December 31, 2009 to the date of signing this report, the Company raised the amount of some

NIS 124.5 million in return for issuing bonds and obtaining loans, as detailed below:

Date of issue Fund Raising Amount in original currency

Amount in NIS

17/02/10 Loan from DZ Euro 24.3 million 124.5 million

25/02/10 Loan from Deutsche Euro 0.195 million 1 million

3.10.5 Restrictions applying to the Corporation by force of Financing Agreements

On the signing date of this report, the Company is not required to comply with any financial

covenants whatsoever (e.g., service debt ratio or date cap. ratio) regarding credit received from

banks or from others. Nevertheless, in part of the loan agreements, the Company is required to

receive the approval of the lender to the transfer of assets that are the subject of the specific loan.

For details on the main restrictions applied to the Company by force of its financial liabilities and

the main grounds for demands for immediate repayment included in the loan agreements and

debentures of the Company, see Note 18(f) to the Financial Statements.

3.10.6 Credit with variable interest

At December 31, 2009 the Company had a total of NIS 5,286.90 million in variable interest credit,

as detailed below:

Interest ranges Interest range in

2009

(in %)

Balance at 31.12.09

(millions) Currency

High Low High Low Original currency

NIS

US$ Libor 6m + 1.7 Libor 6m + 0.15 4.74 2.64 342.1 1,291.6

Euro Libor 6m + 1 Libor 6m + 0.325 6.17 1.32 685.7 3,731.3

Swiss franc Libor 6m + 0.5 Libor 6m+0.5 3.41 0.90 1.1 4.1

GB Pound Libor 6m + 0.5 Libor 6m + 0.5 6.73 1.28 1.6 9.9

Unlinked NIS Telbor 6m + 1.15 Telbor 6m + 1.15 5.65 2.39 250 250

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3.10.7 Credit rating

a. In Israel

In November 2002, before the issue of debentures to the public (series 22), the Company received an (AAA) rating from Ma’alot Credit Rating Ltd., currently named Standard & Poor's Maalot ("Maalot S&P"). In November 2006, Maalot S&P announced a lowering in the rating of the Company debentures in circulation to (AA+/Negative). On March 24, 2009, Maalot S&P announced that it is lowering the Company debentures rating to (ilAA/Negative). Maalot S&P did not change the Company's rating up to the date of this report.

b. Overseas

The Company was rated in 1996 by two international rating companies, Standard & Poor's ("S&P") and Moody's, at (A-) and (A3) rating, respectively. In February 2003, Standard & Poor's announced a lowering the rating of the debentures of the Company to (BBB+/Negative). On March 24, 2009, S&P announced that it lowers the rating of Company debentures to (BBB). The rating of Standard & Poor's did not change up to the report date.

In January 19, 2003, Moody's rating company lowered the rating of Company's debentures by two degrees to (BAA2). In June 2005 Moody’s announced a change in methodology, which led to the Company’s rating remaining at (BAA2) but the negative forecast was improved to a stable forecast. On the date of the report, Moody's rating of the Company remained unchanged..

3.11 Taxation

On this matter see note 22 to the Financial Statements.

3.12 Restrictions and regulation of corporate activity

On this matter see sections 1.7.1 and 1.7.3 of this report.

3.12.1 Provisions of the Electricity Sector Law, its underlying regulations and decisions of the Electricity Authority

On this matter see sections 1.7.1 to 1.7.3 of this report.

3.12.2 Government decisions

On this matter see Note 1. e to the Financial Statements.

3.12.3 The Budget Foundations Law, 1985 (“the Budget Foundations Law”)

The Budget Foundations Law applies to any Government company, Government subsidiary and

involved company.

In addition to the Company’s obligation to operate in accordance with the rules laid down by the

Government and to obtain its approval when determining pay, social conditions, benefits, grants and

other working conditions for its senior and other employees, as stated in section 32(a)(4) of the

Government Companies Law, the Company is also subject to a number of the provisions of the

Budget Foundations Law, which states that Government companies, Government subsidiaries and

involved companies within the meaning of the Government Companies Law, are included in the

definition of “budgeted entity”.

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According to the provisions of section 29 of the Budget Foundations Law, the Company cannot

agree to changes in pay, retirement terms or pensions, or any other monetary benefits relating to

work, and cannot introduce any such changes or benefits, except in accordance with what is agreed

or introduced with respect to all state employees or with the approval of the Minister of Finance.

Notwithstanding the contents of any law, any agreement or arrangement is null and void if it

contradicts the aforesaid provisions. If any budgeted entity fails to comply with these provisions,

the Minister of Finance may deduct an amount equal to the amount paid due to this breach from the

amounts to be transferred to the budgeted entity from the state budget, and may stop or reduce any

grant or participation that the budgeted entity would have otherwise received from the Government,

for as long as the budgeted entity makes payments contrary to the provisions of the Budget

Foundations Law.

A director who knowingly agrees to any changes or benefits contrary to the foregoing shall be

deemed to be a director who is not properly fulfilling his duties, for the purposes of the ministers’

authority to dismiss directors, and consent by the CEO to such changes will be deemed sufficient

cause for the Government to dismiss him.

A budgeted entity must give the Director General of the Ministry of Finance, on demand, any

information he requires for the purpose of monitoring compliance with the Budget Foundations

Law.

A budgeted entity shall give the Supervisor of Wages and Work Agreements in the Ministry of

Finance, once a year, a detailed report on the terms of employment of every office holder, within the

definition of section 33(a) (d) of the Budget Foundations Law, which it employs. The definition

includes the chairman and members of the Board, the CEO and his deputy, the company secretary,

internal comptroller, legal counsel and any other manager directly subordinate to the CEO.

The budgeted entity will also submit to the Commissioner for Pay on demand any arrangements,

agreements and group or individual wage agreements. The Minister of Finance may withhold

amounts due to an entity that fails to comply with the obligation of reporting.

The Supervisor of Wages and Work Agreements may, with respect to any wage agreement that

includes a wage anomaly within the meaning of section 29 of the Budget Foundations Law, audit the

matter, determine temporary arrangements for the audit period, inform the entity and its employees

at the end of the audit that the agreement is cancelled, and of the obligation to cease any deviating

payments, decide what to do with any wages paid under the anomalous agreement and decide what

agreement or arrangement shall apply to the parties instead of the anomalous agreement. See

section 3.7.3(a) in this report on the review of wages excesses by the Supervisor of Wages and Work

Agreements.

3.12.4 Woman’s Equal Right Law, 1951

Pursuant to the provisions of this Law, a public body and the tenders and appointments committees

of a public body shall give suitable expression, in the circumstances, to the representation of women

in the various positions and grades of their employees, in management, the board of directors and

the council, providing that if for the purpose of exercising this provision preference must be given to

a woman, such preference shall be given if the candidates of both sexes have similar qualifications.

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The definition of “public body” includes Government companies, unless the Ministry of Justice

determines, with the approval of the Knesset Committee for the Promotion of Women’s Status, on

the matter of its employees, that the aforesaid duty of representation shall not apply.

3.12.5 Resolving disputes between the Company and the State

Resolving disputes in civil matters between a Government Company and another Government entity.

According to the guidelines from the Government’s legal advisor, it is proper to avoid as far as

possible any court proceedings to resolve legal disputes on civil matters between a Government

Company and the State or a corporation incorporated according to the law or another Government

Company.

Therefore, a Government Company should make all efforts to resolve a legal dispute between that

company and the State, a public corporation or another Government Company by any means other

than filing a claim to the court.

A Government Company that fails to resolve the dispute in any other way and wishes to file a claim

will notify the Manager of the Government Companies Authority in advance.

The Manager of the Government Companies Authority who receives such a notice will take steps to

resolve the dispute by way of negotiations, mediation, providing a legal opinion by a third party,

agreed upon between the parties (including the Government’s legal advisor or whoever is appointed

by him), a committee agreed upon between the parties, or in any other way, according to the case at

hand.

If the dispute is not settled by an agreed upon arrangement between the parties within a reasonable

time and the Government Company still insists on filing a claim, the Manager of the Government

Companies Authority will refer the dispute to the Government’s legal advisor or whoever is

appointed by him.

If the Government’s legal advisor deems it necessary, he will act to settle the dispute in whatever

manner he sees fit, according to the circumstances. If he is unable to do so within a reasonable time,

he will give an opinion to the parties (in a Government Company, even to the Board of Directors of

that company) on the question of what the next steps should be.

If the circumstances require urgent recourse to the Court, in a claim or a request, to avoid missing a

date determined by law, or prevent the situation from changing or prevent other grave damages, an

effort will be made to extend the date of prevent the damages, as the case may be. If all these are not

possible, the company may apply to the Court, as required under the circumstances of the case and

then take the aforesaid steps to resolve the dispute.

Resolving Disputes on Civil Matters between the State and Public Corporations or

Government Companies

The guidelines of the legal advisor outline the recommended course of action, according to which it

is proper to avoid as far as possible any court proceedings to resolve legal disputes on civil matters

between the State and a public corporation incorporated according to the law or Government

companies.

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Therefore, no civil claim shall be filed by the State against a public corporations and against a

Government company, or by a Government company, except after obtaining approval from one of

the following: the legal advisor, the State attorney, the deputy State attorney or the head of the civil

department in the State attorney’s office.

A request for the aforementioned approval will be addressed to the District Attorney, according to

the location or to the head of the civil department in the State attorney’s office, who will discuss the

matter with the legal advisor of the public corporation or with the Government Company and will

act to resolve the dispute by way of negotiations, mediation, providing a legal opinion by the legal

advisor of the Government or whoever is appointed by him, or in another way, according to the

circumstances.

If the dispute is not settled within a reasonable time, the Government's legal advisor will decide on

the next steps.

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Resolving Disputes between Government Companies on Infrastructure Issues

According to section 59b of the Government Companies Law, one or more committees will be

established for the purpose of settling disputes between infrastructure companies in the following

matters:

1) Coordination on infrastructure works.

2) Scope of infrastructure works.

3) Timetables for performing infrastructure works.

4) Payment required for performing infrastructure works.

5) Coordination on the subject of passage through areas held by an

infrastructure company.

6) Another dispute that delays or may delay infrastructure works.

The Committee for resolving disputes will decide on the dispute at hand in the shortest possible time

under the circumstances and no later than the end of forty five days from receiving the application.

The Committee is entitled to extend the said period in light of special reasons, which will be

recorded.

The Committee for resolving disputes will decide on the dispute in a manner that is deems efficient,

fair and just under the circumstances, with due consideration of the applicable law and the public

benefit. The decision of the Committee shall be issued in writing and include arguments and

reasons.

3.12.6 The State Comptroller and the Commissioner for Public Complaints

a. The State Comptroller

The State Comptroller Law, 1958 (Combined Version) (hereinafter: “the State Comptroller Law”) makes every audited body (as defined in the Law) subject to an audit by the State Comptroller (hereinafter: “the Comptroller”) and stipulates provisions regarding the duties of the audited body to provide the Comptroller with documents and information.

The State Comptroller Law grants the Comptroller powers to carry out an audit of a company’s activity, assets, finance, liabilities and administration, as specified in the Law. At the suggestion of the Government or the Comptroller, the Knesset Audit Committee may determine, from time to time, with respect to a particular entity or item in its budget, special methods of audit or restrictions.

An audited body must submit to the Comptroller, on the date determined by him, a report of its income and expenses during its financial year, and any other information, report, document or action plan required by the Comptroller.

The company’s outside auditor must each year submit to the State Comptroller a report pursuant to the State Comptroller’s Notice (Guidelines for a Corporation’s Outside Auditor), 5736-1976.

On completing the audit of the audited body, the Comptroller submits a report of his findings to the Knesset’s Committee of State Comptroller Matters, to the Prime Minister, the relevant minister and the auditing body.

157

The Comptroller issued three audit reports on the Company. Details of the reports and the material findings indicated by the Comptroller are as follows:

1. State Comptroller's report No. 58b, of May 2008 "Agreements for Purchasing Services by the Logistics and Assets Division", relates to the agreements control procedures of the Company.

2. State Comptroller's report No. 59a, of March 2009 "Agreements of the Israel Electric Corporation with a Building Management Company, relates to several aspects of the Company's agreement with CPM Building Management Ltd., (CPM), mainly engaged to manage the completion of the main offices building in Haifa, and supervision over its work.

3. State Comptroller's report No. 59b, of May 2009 "Preparations for Contending with Shortage of Electricity", related to the preparations made by the parties in charge of developing the electricity sector, to prevent shortage of electricity.

The Company is in the process of correcting the faults indicated by the Comptroller.

b. The Commissioner for Public Complaints

According to the State Comptroller Law, 1988 (Combined Version), the Commissioner for Public Complaints may investigate complaints against the company as an “audited entity”, on account of any action or omission or delay in action that directly affects the complainer himself, or directly deprives him of some benefit. The Commissioner’s findings of his investigations and his recommendations for correcting any defects are sent to the audited body.

3.12.7 Purchasing procedure, Tenders

The Obligation for Tenders Law, 1992 (hereinafter: “Obligation for Tenders Law”) imposes on the

State and every Government corporation, as defined in the Law, the obligation to hold a public

tender giving everyone an equal chance to participate. Holding such a tender is a precondition for

entering into any agreement concerning a deal involving goods, land, services or execution of any

work, with the exceptions stated in the Law and the Obligation for Tenders Regulations, 1993, based

on the Law.

As well as the general provisions of the Tenders Regulations, which apply to all entities to which the

Obligation for Tenders Law applies, chapter E of the regulations deals with agreements by

Government companies and Government subsidies, and imposes special additional duties on them.

Company purchases are made by means of public tenders, or by contacting a number of authorized

suppliers (“closed tender”), or by negotiations with suppliers (exemption from tender). The

Company prefers to make purchasing arrangements through public tenders even when the tenders

regulations allow the Company to enter a purchasing agreement through other agreements, unless it

is it is justified and reasonable in the circumstances to enter the agreement through another method.

According to the tenders regulations, when that it is justified and reasonable in the circumstances,

the Company may enter agreements to purchase goods with special and unusual features in a closed

tender by contacting suppliers who meet the requirements and the criteria defined by the Company,

and are on the list of authorized suppliers (provided that there is a limited number of potentially

suitable suppliers for the specific need).

The Company has a unit for authorizing suppliers that works to locate and authorize suppliers who

can meet the Company’s requirements for various goods. The unit’s list of authorized suppliers is

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published by the Company in the Company's website, and suppliers who wish to be included in it

can go through the proper process. .

The Tenders Regulations also define cases where it is possible to enter purchase agreements without

holding a tender, (exemption from tender) after studying the possibility of entering the agreement

through a bid process, insofar as it is justified and reasonable under the circumstances to enter the

purchase agreement in this method. On the basis of the provisions of sections 3 and 4 of the

Tenders Law, regulations 3, 5, 5a and 34 were drawn up. Regulation 34 deals with exemptions from

the obligation of Government companies to hold a tender. For example, in cases where the value of

the transaction is up to NIS 600,000, or in the case of agreements required urgently to prevent actual

damage (where the purchase agreement is required within two work days or less), agreements that

are a continuation of previous agreements, and agreements where a tender could affect the

Company’s profitability, its ability to compete with others, its business opportunity, its ability to

perform the functions imposed on by law, or its ability to provide a service or commodity that is

essential to the public.

Regulation 10 of the Tenders Regulations regulates the work procedures of the tender committee:

decisions are taken by majority vote, with reasons, and recorded in a signed protocol. The Company

has two levels of tender committees, one level for divisional, district or inter-divisional committees,

consisting of employees at techno-administrative grades. In certain cases, according to Company

procedures, these committees refer their decisions to the second committee, the supreme tenders

committee of the Board of Directors, which consists of members of the Board. The supreme tender

committee is authorized to review and supervise the decisions of the divisional and District tender

committees.

Since January 1, 1996 the Company has operated, in addition to the Tenders Law and its associated

regulations, also in accordance with the provisions of the Government Purchases Agreement.

Wherever there is a discrepancy between the Tenders Regulations and the Government Purchases

Agreement, the Israeli legislature has determined that the Purchases Agreement takes precedence.

According to the Government Purchases Agreement, it will apply to tenders to purchase goods

(excluding cables, electro-mechanical meters, transformers, fuses and switches, electrical motors)

and certain types of services listed in the Agreement, for an amount greater than about $532,000

(about $12.75 million for building and road laying work). Such tenders, subject to the Government

Purchases Agreement, must also be published in the press in English and there must be equal

treatment for all bidders, including bidders offering goods made in Israel and those offering goods

made in countries that have signed the Government Purchases Agreement.

With respect to purchases that are subject to the Government Purchases Agreement, there is no

obligation to prefer Israeli made products as there is in the Preference of Israeli Produce

Regulations. For these purchases it is obligatory to have an international tender with fully equal

opportunities for suppliers of goods from all countries in the Agreement. It should be noted that the

Preference of Israeli Produce Regulations continue to apply to international tenders that are subject

to the Government Purchases Agreement with respect to bidders with goods made in countries that

have not signed the Agreement, and in these cases the Company gives preference to Israeli made

goods.

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3.12.8 Permits for Toxic Substances

A permit for toxic substances is a license required pursuant to the Dangerous Substances Law, 1993,

for anyone using dangerous substances, which are defined in the Law. The Dangerous Substances

Regulations (Classification and Exemption) 1996 specify an exemption based on the concentration

and quantity of each substance. The permit for toxic substances is subject to conditions for proper

handling of dangerous substances specified by the permit, aimed at protecting the public and the

environment. The Dangerous Substances Regulations (Criteria) 2003 define the validity of the

permit according to the type of occupation and quantity of dangerous substances required.

The Company engages in a variety of activities involving a wide range of dangerous substances.

The main usage, and in large quantities, is in the generating segment, and during storage in the main

warehouses at coastal power station sites.

All power station sites (fuel oil, coal and gas turbines) have site specific toxic permits that cover the

use of toxic substances at those sites, and associated activities: storage, workshops, and

laboratories. The permits at power stations are renewed each year, and for gas turbines the permits

are renewed once every three years.

There is also a toxins permit for the transmission and transforming division which is renewed every

three years, and a toxins permit for transporting dangerous substances for the national transportation

sector, in the logistics and assets division, which is renewed every two years.

As of the date of this report, the Company performs all the actions required to comply with the

conditions of the permits for toxic substances.

3.12.9 Preparations for dangerous substance incidents - factory files

A factory file is a binding document required by the Regulations on Licensing of Dangerous

Businesses, 1993. This document describes the preparations for preventing and handling incidents

involving dangerous substances that could arise as a result of an operating fault, accident, terror

attack, earthquake or another force majeure. The structure and contents of factory files are outlined

in the legislation. These factory files are submitted on demand to the local licensing authority, fire

fighting service, home front command, Ministry for the Environment, and the Urban Association for

Environmental Quality.

All power plant sites have factory files that are updated as necessary, particularly following the

changes in production units and the changeover to work with natural gas. In the framework of

licensing for operation with natural gas, the factory files are also checked and approved by the

Natural Gas Authority in the Ministry of Infrastructures.

In all power stations the emergency team carries out drills on responses to dangerous substance

incidents, including involving the relevant authorities, the Ministry of the Environment, the Urban

Association for Environmental Quality, the fire service, the police and the home front command.

3.12.10 Quality assurance and control

Standards - all Company units meet the requirements of Israeli standard ISO9001:2000. The

Company’s quality management policy states that the Company is a leading business entity whose

purpose is to develop the electricity sector in Israel and to provide regular supply of high quality,

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competitive electricity, with the emphasis on preserving the environment, maintaining occupational

health and safety and a high level of service. Some units in the Company implement an integrated

management system according to the requirements of ISO 9001, ISO 14001 and/or OHSAS18001

standards and based on the principles underlying the aforesaid policy.

Some laboratories in the Company are certified by ISO/IEC 17025 standard, in addition to the

aforementioned certifications.

Quality control - the Company’s organization, quality and safety division has a quality control

sector, whose functions are as follows: to control the quality of products purchased by the

Company, from the stage of preparing the quality requirements in the product specifications attached

to the purchase order, until the product is received by the Company; to give professional advice to

Company units on quality control, at their request; to participate in handling any faults found in

products made for the Company; to participate in handling complaints from Company units

concerning defects discovered while using products.

3.12.11 Planning and building

All Company facilities are set up in accordance with building permits issued pursuant to the

provisions of the Planning and Building Law, 1965, excluding the erection of electricity grid

facilities, as defined in the Planning and Building Regulations (Regulating Transmission,

Distribution and Supply of Electricity) 1998, which is done in accordance with permissions granted

by virtue of the Planning and Building Law and the aforesaid Regulations.

If the Company discovers that any work requiring such permits was not done according to the law, it

works with relevant authorities to obtain the legally required permits.

Pursuant to the instructions of the National Council for Planning and Building, outline plans are

required in order to erect 400 kV lines. The outline plans and the procedures for approving them

comply with the provisions of the Planning and Building Law. Recently the Ministry of the Interior

has adopted the position that the erection of 161 kV lines also requires preparation of a detailed

outline plan (this position is expressed in an internal directive of the Ministry and in combining the

said requirement in the different local and District outline plans). The Company opposes this

position for the reason that it is not compatible with the provisions of the applicable law. This issue

was discussed with the Deputy Legal Advisor to the Government, who accepted the Company’s

position and stated that the authorization procedure stipulated in the law is suitable for approval of

161 kV lines subject to “improvement of the authorization procedure”. In the opinion of the

Ministry of the Interior, the conclusion of the Deputy Legal Advisor of the Government is phrased

in a manner that allows the planning committees to exercise their discretion on including

instructions in the outline plan stipulating that the erection of 161 kV lines will be entered in the

plan. Therefore, the Ministry of the Interior holds to its policy, stating that 161 kV lines will only be

approved according to a detailed outline plan. Consequently, the Company filed a petition to the

Supreme Court, sitting as High Court of Justice to declare the aforementioned internal directive of

the Planning Administration and amendment to the outline plan of the Southern District null and

void. The petition is pending.

In a preliminary reply to the petition, the state claims that the court has no reason to intervene, since

there is no fault in combining a directive that requires an outline plan as an obligatory requirement

for outline plans and also since in all matters related to the directive of the planning administration,

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this is an early petition. In the hearing for the petition on October 1, 2009, the court suggested that

the parties should attempt to reach a compromise on the suitable planning outline for erecting 161

kW lines. The parties are holding talks in an attempt to reach such a compromise.

The owner of rights to land may submit a claim for compensation for a drop in the value of such

land as a result of approving the plan, against the local committee to whose jurisdiction an outline

plan applies. The Company has undertaken to indemnify the local committees within whose

jurisdiction these plans apply, with respect to certain plans, for the full amounts that the committees

may be obliged to pay to the owners of land who are affected, all subject and according to the stated

in the version of the indemnification letters (apart from one plan in which the burden of

compensation will be divided between the institutions involved in the plan). In appeals submitted to

related appeals committees against the local committees, on the subject of decreased value.

According to the instructions of the indemnification letters, the Company was added to the appeals

as a party that may be affected by receipt thereof (See also note 24.b.7 to the Financial Statements).

The indemnification letters do not specify sums. The letters require indemnification of 100% of the

value of the claim (appeal) filed against the local committee. The total sum of the claims is detailed

in the Financial Statements and is updated from time to time,

3.12.12 Business licensing

a. The Company acts to arrange business licenses for items requiring such licenses at its facilities,

pursuant to the Business Licensing Law, 1968, and by virtue of an internal Company procedure

on this matter, activity that involves making changes and adjustments to meet the requirements

of competent bodies under any law. On the report date, the various generation units in the

generation segment hold business license that are extended or renewed from tine to time.

b. Business licenses have already been obtained for the majority of power stations and also for

some of the items in logistical and administrative facilities. Regarding other items, a special

team from the Company is occupied at the date of this report, in locating the remaining items

that require licensing and submitting applications for the licenses. Based on past experience

and on current available information, the Company estimates that its actions to obtain business

licenses are not expected to have material implications for the operation of the main Company

sites/ facilities.

For environmental conditions in business licenses, see section 2.1.13 of this report.

On the obligation to prepare factory files pursuant to the Licensing Regulations for Dangerous

Businesses, 1993, see section 3.12.9 above.

3.13 Trade Restrictions Regulations

On January 5, 1999 the Commissioner for Trade Restrictions (“the Commissioner”) announced, by

virtue of his authority pursuant to the Trade Restrictions Law, 1988 (“the Trade Restrictions Law”),

that the Company has a monopoly in the area of supplying (generating and selling), transmitting and

distributing electricity, and providing backup services to electricity consumers and producers. The

announcement of the Commissioner is only declarative. This announcement in itself does not change

the status of the Company as a monopoly holder.

3.13.1 The statutory tools stipulated in the Trade Restrictions Law grant the Commissioner, inter alia, the

right to demand that the uniform contracts be submitted for his approval, and the right to intervene

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in any Company activities that could affect the public or competition, including referral to the Trade

Restrictions Court (“the Court”) with a petition to split a monopoly into two or more separate

business corporations.

3.13.2 On May 4, 1999 the Company submitted an appeal against this decision of the Commissioner in the

announcement to the Court, following which, on March 19, 2001, the Company reached an

agreement with the Commissioner, which was given the validity of a ruling, as follows:

a. The Company has a monopoly in the electricity sector, including the following components:

supply - the generation and sale of electricity, transmission and distribution of electricity,

provision of backup services to electricity consumers and producers.

b. The provisions of chapter D of the Trade Restrictions Law (on the subject of a monopoly)

apply to the Company as a monopoly, both in the electricity sector in general and in each of its

segments, as detailed in paragraph (a) above.

3.13.3 Up to the date of signing this report, the declaration that the Company is a monopoly had no

material effect on its activity, profitability or financial situation. In view of the existing level of

supervision of the Company, by the Electricity Authority and other authorities, and in view of the

structural changes required by the provisions of the Electricity Sector Law, including the

incorporation of generating units into separate subsidiaries (see section 1.7.1, 2a of this report), the

Company cannot estimate the future implications of this declaration on its activity, profitability or

financial situation, although it is possible that it will have significant implications.

The information on the implications of declaring the Company as a monopoly is forward looking in

nature, as defined in the Securities Law. The said information is based past experience and current

information and data available to the Company at the date of this report. on future data of an

uncertain realization nature, which are not under the sole control of the Company and depend on

decisions of the Government/ Ministers/ regulatory amendments. Nevertheless, the said declaration

may be affected by external factors outside the Company's control, including materialization of any

of the risk factors detailed in section 3.17 in this report.

3.13.4 In addition to the foregoing, the Company is subject to all the provisions of the Trade Restrictions

Law, including on the subject of binding arrangements and mergers. It should be noted, that as a

monopoly, a merger of the Company with any other company is subject to the provisions of the

Trade Restrictions Law on the matter of mergers.

The Company implements an internal enforcement plan on trade restrictions.

3.13.5 The implications of the declaration of the Company as a monopoly on the purchase of

electricity from private producers

a. On August 5, 1997, the Company, on the instructions of the Ministry of National

Infrastructures, published a tender to set up a private power station at Ramat Hovav with an

available capacity of 370 MW. The terms of the tender include a stipulation that the winner

shall undertake to sell to the Electric Corporation, exclusively, all the electricity generated at

the power station for a period of twenty years.

Following a request from the Commissioner, arguing suspicion of a binding arrangement, the

tender contained a provision that it would be cancelled if the Court failed to approve the

aforesaid arrangement.

163

b. The Company asked the Commissioner for exemption for this binding arrangement. The

Commissioner refused and would only agree to an exemption for the binding arrangement for a

limited period until 2006. As a result, the Company petitioned the Court for approval of this

binding arrangement.

c. Before the Court gave its verdict, and when the Company was declared a monopoly, the

Commissioner informed the Company that he was considering issuing instructions to the

Company, by virtue of his authority under the Trade Restrictions Law, regarding the conditions

for holding the aforesaid tender.

d. On March 22, 1999, the Court gave a verdict in which it did not approve the binding

arrangement stipulated in the tender, stating that this arrangement was damaging to competition

and not compatible with the intention of the legislature in the Electricity Sector Law.

e. As for the Commissioner’s request that the Court instruct the Company to continue with the

tender after removing the items on exclusivity for selling electricity to the Company, the Court

expressed an opinion that it was doubtful this could be done, whether according to the laws of

tenders, or in the absence of the Company’s consent so long as the Minister of National

Infrastructures had not defined rules for deals concerning the purchase of electricity from

private produces pursuant to section 20(b) of the Electricity Sector Law.

f. On September 10, 2000, the Minister of National Infrastructures published such rules (Rules for

the Electricity Sector (Deals with an Essential Service Provider), 5760-2000). Section 9 of

these rules stipulates commencement of the rules on September 11, 2000 and they would also

apply to deals where proceedings began before that date and were not yet completed.

g. As a result, the Company reached an agreement with the Trades Restrictions Authority

regarding private electricity producers with whom the Company has agreements (see section

2.1.4 of this report), as follows:

1. The Company would inform the existing private electricity producers that the exclusivity

agreements between these private producers and the Company were immediately

terminated.

2. The private electricity producers could stop selling all or some of the electricity generated

by them to the Company, with prior notice.

3. New agreements signed between the Company and private electricity producers and

subject to the Rules for the Electricity Sector (Transactions with an Essential Service

Provider), 5760-2000, would not include exclusivity conditions.

h. Following the Court’s ruling based on the rules published by the Minister, changes were made

to the draft agreement with the private producer at Ramat Hovav in line with the aforesaid

rules.

See also section 2.1.4.2 f in this report.

Regarding the data demanded from the Company by the Trades Restrictions Authority on the

Business Development Unit, see section 3.1 in this report.

164

3.14 Material agreements

The agreements described below are material agreements outside the normal course of

Company business, and which are not described elsewhere in this report.

The desalination facility at the Orot Rabin site

On September 7, 2004, the State and the Company signed an agreement that the Company would

grant the State or an entrepreneur chosen by it (H2ID) the right to use land of about 71 denims within

the grounds of the Hadera power station, to set up a sea water desalination plant. The right to use the

land would start on a date determined by the Government (“the determining date”) and would be

given for a period of 24 years and 11 months. On December 10, 2007 the State announced that this

was the “determining date”.

In return for granting this right of use, the Company received a one time payment of approximately

NIS 7.5 million to cover the costs of removing structures on the land to be handed over to the

concession holder and moving them elsewhere on the power station grounds and also, a one time only

amount of approximately NIS 762,000 for coordination, planning and supervision actions, starting

from 30 days after the determining date (namely, starting on January 9, 2009). The Company receives

NIS 1,200,000 each year in December 2009 prices (linked to the Consumer Price Index). In return for

services provided by the Company to the operator, from the start of production of desalinated water at

the plant, the Company would be entitled to a payment of 0.24 cents for each cubic meter of

desalinated water sold by the operator to the State (the facility was intended to supply some 127

million cubic meters of water each year).

The facility commenced operation at the end of 2009.

165

3.15 Legal proceedings

Several class actions and other significant claims have been filed against the Company. For details

see Note 24 to the financial statements.

3.16 Strategy and objectives

3.16.1 Vision

The Company strives to continue being the leading commercial Company in Israel in the electricity

generation and supply sector and be a role model of quality, excellence and reliability to our

consumers, employees and shareholders. The Company will act to attain the position of one of the

best electricity companies in the world, while continuously striving to attain higher efficiency and

quality of its performance, in response to the requirements and expectations of Company's

customers. The Company will continue the tradition of its founders by contributing to the growth of

the State of Israel.

3.16.2 Main Values

The Company is customer oriented. Its employees are the most important asset. The Company acts

through a business perspective, emphasizing quality and reliability of all its actions, with high

awareness of the community and the environment.

3.16.3 Main objectives

1. Attain higher service quality while adhering to the covenant between the Company and its

customers, improve supply reliability, meet timetables, provide training and professional advise

to customers and respond to public needs with the required flexibility.

2. Attain financial strength, while increasing competitiveness, productivity and profitability.

Introduce technological improvements and locate additional market sectors.

3. Foster the human resource while constantly training and enhancing employees professional

expertise and motivating them. Enable employees participation and encourage innovation and

excellence. Cultivate employees to management positions. Ensure appropriate work conditions

and wages and care for the welfare of the employee and his family

4. Act responsibly on national and community issues, including preservation of the environment,

contribution to community project, enhancement of public safety, support and encourage the

local industry, realize technological progress and participate in outlining the energy policy in

Israel and in the Middle East.

3.16.4 Means of achieving these objectives

a) 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.

b) Optimal integration of production means using natural gas into the development work in the

current decade.

166

c) 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.

d) Developing the distribution system in line with customer demand while minimizing costs.

3.16.4.1 Operation

a) Assimilating a policy of environmental operation and development.

b) Optimal operation of means of production.

c) Implementing a policy of optimal operation and maintenance, to ensure availability during peak

demand, and renovations at the lowest possible cost.

d) Using the optimal mix of fuels to operate the generation system.

3.16.4.2 Customers

a) Developing new products and services for customers (reducing frequency agreements,

reliability rates, and so on).

b) Providing service with reference to the needs of different market segments, including strategic

customers, making use of a special model.

c) Fostering links with Company customers as part of management policy.

d) Strengthening the Company’s links with the community through initiated activities, cooperation

with environmental bodies, etc.

3.16.4.3 Resource management

a) Maintaining, optimizing and fostering the human resource by developing tracks for

advancement and professional and managerial training.

b) 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.

c) Adapting the structure of Company liabilities to the structure as recognized in the electricity

rates.

d) Financial management that facilitates improvement of the financial results, upgrade the

Company’s rating and consequently its ability to raise funding for its development plans.

3.17 Discussion of risk factors

The Company estimates that it is exposed to several primary risk factors, arising from the economical

situation and the unique characteristics of the Company, specified below: (the risk factors described

below do not include risks in the Company’s main area of activity, such as the risk of a large-scale

technical problem, or the effects of future technological changes, or the general risks applying to any

large corporation, such as earthquakes, storms etc.).

The following table presents the risk factors of the Company, scaled according to estimates of

the Company on the extent of the effect of this risk factor on Company activity:

167

Effect Risk Type

Category

Sub-Category

Large Material effect on Company Objectives

Moderate Moderate Effect on Company objectives

Low Minor effect on

Company objectives

1. Damaged image X 2. Natural gas supply

and delivery Failure/damage to the natural gas supply and the natural gas delivery systems

X

a. Strategic Risks

3. Natural disasters (earthquake/ flooding/ storm) and fires

X

4. Security events War X Terror X 5. Geopolitical

situation Dependence on foreign sources

X

6. Competition Entry of new operators and renewable energies

X

7. Unrealized forecast long term demand

X

1. Compliance risks Permits and Licenses X b. Compliance and regulation

2. Regulatory risks The Company is exposed to strict regulatory demands required by different parties: The Ministry of National Infrastructures, Government Companies Authority, Electricity Authority, the Ministry of Finance, the Ministry of Environmental Protection, the Ministry of Labor, the Securities Authority

X

Information Technology

1. Failure of the information systems

X

2. Information security - hacking into the system

X

3. Environment X c. Operational

4. Safety Employees and third party safety

X

Risks Human Resources 5. Labor relations X 6. Human errors

X

7. Knowledge Knowledge management and retention

X

8. Supply chain X 9. Strategic suppliers X 10. Generation X 11. Embezzlement and

fraud X

12. Failure to fulfill the development plan

X

Market Risks 1. Exposure to changes in exchange rates of foreign currency for the balance of loans

X

2. Exposure to market risks

168

Effect Risk Type

Category

Sub-Category


Moderate Moderate Effect on Company objectives

Low Minor effect on

Company objectives

of pension fund investments

X

Liquidity Risks 3. Financing the development plan

X

d. 4. Obligations to lenders X Financial 5. Funds raising ability X Risks 6. Capital structure X Credit and securities

risks 7. Banks risks X

8. Doubtful/ lost debts X 9. Legal Class actions X 10. Income Rate determined does not

cover Company costs X

11. Financial statements and internal audit risks

X

See section 6 f to the Board of Directors Report for more information on risk factors.

Amos Lasker Dr. Ziv Reich Chief Executive Officer External Director

Report approved on: March 31, 2010

o

The Israel Electric Corporation Ltd.

Chapter B Board of Directors' Report on the Status of the Corporation's Affairs

For the Year Ended December 31, 2009

Prominent Disclaimer

This English translation of the "Company's Board of Directors'

Report on the Status of the Corporation's Affairs" for the year

ended December 31, 2009 ("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.

The Israel Electric Corporation Ltd. Board of Directors' Report on the Status of the Corporation's Affairs


3

The Board of Directors of the Israel Electric Corporation hereby presents the Directors’ Report on the status of the corporation's affairs for the period ending December 31, 2009, according to the provisions of circulars of the Government Companies Authority and the Securities Regulations (Periodic and Immediate Statements) - 1970. Explanations of the Board of Directors on different issues are presented hereunder.

1. Business Position of the Corporation

A. Brief Description of the Company and its Business Environment. The Company acts as one combined and coordinated system that deals in supplying electricity to consumers, starting from the electricity generation stage through transmission, distribution and supply of electricity and trade therein. The Company also deals in the construction of the infrastructure required for these activities. Company operations include three main fields: Generation, transmission and transformation of electricity and its distribution. The Company provides electricity to most of the State’s consumers of electricity, and customer distribution is such that it is not dependent on any of them. The Company is owned by the State of Israel which holds about 99.85% of its share capital, therefore the Company and its operation are subject to the directives of the Government Companies Law – 1975. As of March 5, 1996, the Company has operated according to the Electricity Sector Law – 1996 (hereafter: “the Electricity Sector Law”) and its regulations. The Electricity Sector Law replaced the Electricity Concessions Order. The duties of the Electricity Authority, founded according to this ordinance, are, among others, to set rates and define rate update processes, to award licenses and to supervise fulfillment of instructions specified in the licenses. For additional details on the Electricity Sector Law, see Note 1b to the Financial Statements. The Consolidated Financial Statements of the Company ("the Financial Statements") fulfill the directives of the Government Companies Regulations (Rules for Preparing Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order) – 2004 and their amendments ("Government Companies Regulations") and are in accordance with the directives of the Securities Regulations (Preparing Annual Financial Statements) – 2010. The Company consolidates the National Coal Supply Corporation in its Financial Statements.



4

1. Business Position of the Corporation (continued) B. Restatement Of Financial Statements For Previous Reporting Periods

1. Pursuant to a decision of the Board of Directors of the Company, the Company launched a new salary research ("The Research") during the second quarter of 2009. Initial results of the research (based on a different methodology to previous salary research conducted by the Company), show that the current mechanism used by the Company, which promotes pensioners once every several years to a higher rank, will actually cause a real erosion of the pension (under the current assumption of employees taking early retirement, assuming that new ranks will not be developed in future), contrary to the formerly prevailing pension development assumption of an annual pension development rate of 2%.

2. In light of these findings, the Company's Board of the Directors requested to receive the opinion of the Company's Management on pension development in the future. The Company's Management presented its position, stating that the assumed pension development rate in the future shall not be less than the Consumers Price Index ("CPI"). This opinion is based inter alia on the following: • The collective agreement entered for the public sector in April 2008 includes a section

stating that the determining salary update mechanism of a pensioner will be amended by linking it to the CPI instead of linking it to a salary of an active employee. It was also agreed to grant compensation for erosion to tenured pensioners. The said linking of the pension was updated by law.

• This is the position of the Government Companies Authority, as expressed in the past in its comments to the Financial Statements of the Company.

• The intention of the parties that established the pensioners’ promotion in ranks currently used by the Company was to establish a mechanism that will prevent real erosion of the pension, at a minimum.

• On August 9, 2009 a collective agreement was entered between the Company and the Company's employees committee, approved by the Supervisor of Wages and Work Agreements in the Ministry of Finance. According to the new collective agreement, the parties will conduct discussions that will include, inter alia, the issue of transition of the budgetary pension arrangement to a mechanism of linking the pension to the CPI and/or any other arrangement. As of the date of the Financial Statements, there are understandings between the Company, the employees committee, the Histadrut and the Supervisor of Wages and Work Agreements in the Ministry of Finance. The parties reached an understanding on the transition of the budgetary pension arrangement to a mechanism of linking the pension to the CPI and on offsetting sums. The understanding did not mature to a signed agreement as yet (see Note 19(a)(2)(c) to the Financial Statements).

3. The Company failed to reach an understanding with the external auditor on the correct accounting treatment which developed into two main disputes: • The First, do current conditions of the pension plan of the Company enable inclusion of

the assumption described in section (2) above. • The Second, whether the required accounting treatment of the decrease in the estimated

pension obligation should be a change of estimates or a correction of an error that requires restatement of the Financial Statements.

4. The Company's Management and Board of Directors were of the opinion, also supported by professional opinions, that the Management's assumption regarding pension development in the future, for the purpose of presenting the actuarial liability in the Financial Statements, can be relied upon and that the correct accounting treatment is through a change in estimates and not through correction of an error.

5. In light of the aforementioned, the Company addressed the Securities Authority on August 6, 2009, requesting to receive a pre-ruling on this issue.



5

1. Business Position of the Corporation (continued) B. Restatement Of Financial Statements For Previous Reporting Periods (continued)

6. The Company received the preliminary guiding decision of the Securities Authority on

August 26, 2009, stating that the Company should apply an actuarial assumption regarding future increases in pensioners’ salaries that is mutually compatible with the Company's assumption regarding its active employees, applied to its Financial Statements, which is based on the most up to date actuarial research in the possession of the Company, stating that the real decrease in the ranking scale of the active employees (while neutralizing the effect of promotion to a higher rank in the ranking scale) is approximately 1.54% per year. The Company must also restate its Financial Statements.

7. It should be noted that the Securities Authority added another decision to its decision, stating that the date for publishing the Financial Statements as of June 30, 2009, will not be extended and will be August 31, 2009 (namely four days after making the decision).

8. The Board of Directors of the Company decided to act according to the decision made by the Securities Authority and appealed again to the Security Authority, requesting an extension for publishing the Financial Statements. This time, Securities Authority granted the Company a first extension up to October 31, 2009.

9. Subsequently (mainly in light of the fact that the Company's Actuary did not cooperate with the Company for a month from the first extension period and only resumed cooperation with the Company after the Company appealed to the Haifa District Court on the issue and gave him an indemnification letter), the Company received another extension from the Securities Authority up to December 24, 2009. The Securities Authority clarified that it will not grant any additional extensions to the Company for submitting the Financial Statements as of June 30, 2009.

10. In light of the aforesaid, the Company, as guided by the Board of Directors, directed intensive efforts and particular attention to meet the schedules set by the Securities Authority, since the presentation of the Company's Financial Statements required complex calculations spread retroactively over many years.

11. Moreover, additional issues arising as a result of the research, related to the Company's actuarial liabilities volume (mainly regarding the salary development of active employees) came up during the preparation of the Financial Statements. The Company treated these findings following professional consultation with the external auditor, bearing in mind that the Company was bound by its obligation to meet the defined timetables.

12. Accounting results as of the March 2009 report of all the aforementioned and section 14 below, are: To decrease the actuarial liabilities of the Company by a sum total of approximately NIS 8.9 billion, decrease the fixed assets of the Company by about NIS 1 billion and increase the Company's equity by NIS 4.5 billion, net after tax effect.

13. The Board of Directors believes that in light of the current negotiations between the Company, the Employees Committee and the Supervisor of Wages and Work Agreements on the pension update mechanism, and in light of the understanding detailed in section 2 above, which did not mature into a signed agreement, a material part of the decreased actuarial liability will be added to the actuarial liability as at the signing dated of this report. The Company estimates implementation of the aforementioned understanding will increase the actuarial liability by approximately NIS 2.8 billion (on the agreement signing date). This is a future looking statement, subject to realization of the aforementioned assumptions.

14. The Company also presented provisions in the amount of NIS 1,950 million for refunding with respect to the effect of the restatement on the long term liabilities item in the Financial Statements. The provision was recorded with respect to the difference between previous calculations used to determine the rate and new calculations, calculated following the restatement. It should be noted in this context, that as aforementioned, the Board of Directors believes that an arrangement including a new pension update mechanism will be entered in the near future, which will increase the actuarial liabilities. Moreover, the Company's Board of Directors believes that the Electricity Authority will not act reasonably if it only examines



6

1. Business Position of the Corporation (continued) B. Restatement Of Financial Statements For Previous Reporting Periods (continued)

the rate implications related to the restated components of the Financial Statements and that

the Electricity Authority should examine the rate coverage of the actuarial liability as a whole (in this respect the Company has many claims, stating that the current rate coverage is lower than that required to cover the Company's actuarial liability and even applied to the Electricity Authority to receive such coverage (see Note 3to the Financial Statements).

Therefore, the Board of Directors believes that it is too early to estimate any final effects of this provision on the cash flow of the Company. This is a future looking information, subject to realization of the aforementioned assumptions.

C. Assessment of the Financial Impact of the Difference between Financial

Reporting Principles as Applied in the Financial Statements of the Company and the Financial Reporting Standards as Applied in IFRS Under the Government Companies Regulations the Company is required to assess and present the estimated impact of the implementation of the financial reporting rules in its Financial Statements as compared with International Financial Reporting Standards as follows:

December 31,

2009 December 31,

2008 NIS in millions Impact on shareholders’ equity – prepared under the Regulations

Decrease in impact due to implementation of the standard for Regulated Companies

(3,700)

(1,579)

Increase in impact of the IFRS 4,200 1,746 Total increase in shareholders’ equity

500

167

Impact on net income – prepared under the Regulations

Increase (decrease) in impact due to implementation of the standard for Regulated Companies

1,600

(312)

Increase (decrease) in impact of the IFRS 3,000 2,078 Total increase (decrease) in net income 4,600 1,766

Sums presented are before the restatement. It will be noted that the quantitative data presented above represent an assessment and estimate only, and it should be emphasized that any reference to this data should be made with particular caution, since the Company maintains its reporting systems according to the Government Companies Regulations.



7

1. Business Position of the Corporation (continued) D. Electricity Authority Decisions

The Electricity Sector Law states that the Company’s rates shall be set from time to time by the Public Utility Authority - Electricity (hereby: “the Electricity Authority”) based on the cost principle. The Company and the Electricity Authority have disagreements concerning a series of material issues involving highly significant sums. The Electricity Authority’s lack of recognition of these issues caused and will continue to cause a significant decrease in the Company's revenues and to the lack of recognition of some of its assets, which leads to losses and to substantial erosion in shareholders’ equity. The list of major issues in dispute includes, inter alia, setting a normative fuel package, pension expenses and operation starting date of combined cycle gas turbines.

1) A New Rate Base for the Generation Segment (for the years 2010-2014) a) On February 1, 2010, the Electricity Authority reached a decision on updating the new rate

base for the generation segment for the years 2010-2014, and on updating the rate structure book relating to the demand classification groups and the consumption distribution and the . compensation formula for the delay in rates update, to be applied to all electricity chain segments. This decision and rates deriving from it came into force on February 15, 2010. Under this decision, the Electricity Authority updated the rate base for the generation segment for the years 2010 – 2014, updating rate components, including capital costs operating costs, fuel mixture and more. The update does not include any reference to the pension costs of Company's employees. The recognized costs were determined after the Electricity Authority conducted a costs control of Company costs, as recorded in its records over the years

The main issues principles of the new rate base for the generation segment are as follows: (1) Depreciation and Assets Base Assets recognized in the new rate base for the generation segment were determined

according a future outline for 2010-2014 and will be updated every year. Recognized cost with respect to generation units was determined according to the development plan that includes the list of recognized units and their dates of first operation and not according to the increase in sales as implemented in the current rate.

The generation units were divided into two main types: "Old" units - generation units that commenced operation before December 31, 2002.

Recognition of the costs of the "old" units is mainly based on costs thereof in the Company’s books.

Conversion to gas investments will be recognized from the annual update date only after commencing operation with gas.

"New" units - generation units that were operated and that will be operated after December 31, 2002. Recognition of the costs of the "new" units is determined according to normative parameters, e.g., operation dates, building duration and normative interest. The "new" units were divided into two according to recognized rate aspects: − CCGTs outside of the emergency plan (except Tsafit stage B) (units 1-10). − CCGTs defined as "emergency" + Tsafit Stage B (units 11-21).

Recognized equipment costs of the "new" units, where construction has already started (units 1-10) are based on costs of contracts entered into by the Company. Equipment costs of CCGTs defined as "emergency" projects and of Stage B (units 11-21) were determined in a normative manner, using data from the Gas Turbine Handbook (GTH) (average costs in the global market) adjusted to the Company.

Development and installation costs (all costs except equipment, interest incurred during the construction and exceptional costs) of the new units will be recognized in a normative manner, based on an average of historical costs of building a gas turbine, a steam addition and CCGTs, in accordance with costs audit, performed by the Electricity Authority. In the event that units under construction incur costs, that are excessive in the opinion of the Company, the Company may request the Electricity Authority to recognize these costs for the subsequent annual update following the actual operation date of the unit.



8

1. Business Position of the Corporation (continued) D. Electricity Authority Decisions (continued)

1. A New Rate Base for the Generation Segment (continued) The normative development and installation costs were divided into two groups:

a. Costs of Company employees are linked to changes in the average monthly salary of an Israeli employee do not include, at this stage, pension costs of generation A and generation B employees and pension costs with respect to free electricity, holiday gifts and bonuses for generation C employees, until the audit is completed and a final decision is reached on the pension issue.

b. Contractors costs, linked to the index of input in residential building.

Financing cost during the construction period is based on normative construction duration and normative, recognized interest rates.

(2) Fines on Failure to Meet Timetables In accordance with the decision of the Electricity Authority, if the Company fails to meet

predetermined normative timetables for commencing operation of generation units, the recognized income of the Company will be decreased under a fines mechanism, calculated on a daily basis.

A formula for calculating fines with respect to failure to meet normative operation dates of the following "new" units which have not yet commenced operation: Haifa 3 and 4, Alon Tavor "emergency" and stage B of Eshkol "emergency", Hagit "emergency" and Ramat Hovav 8 "emergency", Tsafit second stage. The penalty for each unit will be calculated according to the number of delayed operation days from the normative operation date. The fine mechanism as specified in the decision of the Electricity Authority on June 29, 2009, still applies to the three "emergency" gas turbines (Eshkol, Hagit and Ramat Hovav – unit 8) (see also Note 3 a 1) (3) to the Financial Statements).

The penalty rate for a delay in construction of a steam unit addition is 75% of the fine for a delay in construction of a gas turbine unit.

Maximum fine may amount up to 25% of the unit cost. (3) Financing Costs Financing costs will continue to be recognized in a normative manner, based on the

recognized operating assets. The recognized leverage remains one third equity and two thirds foreign capital. The recognized return on foreign capital is derived from three components: The NIS financing basket component reflecting loans raised in the local market; a hedged financing basket component derived from a new hedging mechanism and NIS at higher interest rates financing basket component reflecting loans in foreign currency for which the Company is required to initiate hedging transactions.

The financing basket of the foreign capital will be divided into three components: o The NIS financing basket - for which an average real NIS interest rate will be

recognized. o The hedged financing basket - for which the following components will be

recognized: an average, real NIS interest rate, the hedging obligation spreading rate for the Company or of the Company with respect to basket differences – index and interest differences between the average foreign currency interest rate and the average, real NIS interest rate. A decrease in the hedged financing basket was defined up to its cancellation within three years. The previous hedging mechanism was cancelled, the debt to consumers will be returned to the consumers over five years.

o NIS financing basket at higher interest for which an average, higher, real NIS interest rate will be recognized. Recognized yield rates on foreign capital linked to the CPI and to exchange rates were determined according to the Financial Statements for 2007, while using the rolling formula for 2008 (and every subsequent annual update).



9


1. A New Rate Base for the Generation Segment (continued)

Return on Equity The return on equity in the generation segment will be 7.35% (9.5% before tax) compared to 7% in the previous base. Total recognized financing costs will be the multiplication of the weighted recognized yield rate (equity and foreign capital) by the recognized assets basket, from which the reserve for deferred taxes will be deducted.

(4) The Hedging Mechanism The new rate base book for the generation segment for the years 2010-2014 states that

the hedging mechanism was updated for all segments of the electricity chain. The main principles of the mechanism are as follows: • The initial estimate of a hedging fund is approximately NIS 12,065 million

(according to the determining basket of February 2010). The sum of the hedging fund will be updated in the annual updating date, according to the recognized assets and to the decreasing plan published by the Electricity Authority, up to the complete cancellation of the mechanism.

• The hedged sum will be linked to the US$ and to the Euro at 75% and 25% rates, respectively.

• Refund of interest in foreign currency in excess of the NIS interest is part of the mechanism.

• Amounts accumulated to the credit or debit of the Company will be spread up to the end of the hedging mechanism in April 2013. However, it should be noted that in light of the expected structural changes, the Electricity Authority freezes its increased outline of the NIS financing basket up to March 31, 2011, or up to the initiation date of the structural change process, at the earliest.

• The efficiency in the new rate base is based on operation components only, therefore, the efficiency is not applied to the hedging component.

(5) Operating Costs Recognition of operating costs in the new rate base were determined based on past

costs, adjusted for an increase in sales. A 2% annual amortization factor is applied to these costs. The Electricity Authority did not complete the audit of the pension costs and upon reaching a final decision in this subject, this component will be updated accordingly in the recognized operating costs. The rates book includes an adjustment of pension costs to the amendment on the restatement of the financial statements.

The following costs were reclassified in the rate as operating costs: − Investments in operational power stations. − Joint assets capital costs. − Spare parts capital costs. − Adjustment for costs of free electricity (exceeding average household

consumption). − Fuels accompanying costs added to fuel prices. − Coal ash treatment, crude bottoms depreciation, electricity consumption in

Company facilities. Operational salary costs are linked to the salary of an Israeli employee position.

According to the Electricity Authority's decision, only half of the spare parts capital costs will recognized as calculated by the Electricity Authority for 2002-2006. This component is recognized under the recognized operation costs and will therefore increase each year according to the increase in sales, less a 2% amortization factor, determined by the Electricity Authority.



10


1. A New Rate Base for the Generation Segment (continued) (6) Fuels Costs The fuels basket will be calculated every year as an average of fuel baskets according

to a forecast of load curves related to different climates. The fuels basket will be retroactively updated every year, according to the actual demand curve and arising from new, relevant professional information. The difference will be refunded to the consumers or to the Company with interest and linkage. In addition, starting from the new rate base, the fuel mixture will be calculated and applied on a calendar basis for that year (January – December).

The Electricity Authority defined in advance the majority of the parameters to be used to calculate the fuel mixture throughout the trial period, including operation dates of generation units. The Gas Incentive provided by the new rate base is limited to the years 2009 - 2012 to new gas agreements only.

2) Updates for the Transmission and Distribution Segments Pursuant to setting a new rate base for the generation segment, the Electricity Authority

also updated some of the components for the transmission and distribution segments. Return rates on foreign capital were updated for the high voltage and low voltage transmission and distribution segments, similar to the updates in the generation segment. In addition, a new hedging mechanism was applied to these segments.

3) The Effect of the new rate base on the financial statements of the Company The Company submitted its initial primary objections to the determined rate. Its main

objections are detailed below: The new rate base does not provide the appropriate solution to the needs of the Company.

It does not bring any improvement in the financial condition of the Company and is almost certain to cause heavy losses. It should also be noted that the Company did not receive any compensation for losses incurred by the delay in the rates update. It is already clear that the rate base does not provide a solution to the Company’s expenses required for both the current year and during the remaining examined years and will not enable the Company to make the investments required to develop the Electricity Sector. The announcement of the Electricity Authority, stating that the rate reflects an addition of 7.8% to the recognized cost for the segment (excluding fuels), is misleading, since about half the addition is derived from shifting investment costs to operating costs, which in practice is preemptive cost coverage that does not increase the Company's profitability in any way. Moreover, the presented rate level is implicitly misleading, since it is ultimately clear to both the Company and the Electricity Authority, right from the start, that the recognized cost will be decreased by the arbitrary fines mechanism defined by the Electricity Authority.

As of the publication date of the financial statements, the Company is still studying the full implications of the new rate base.

The Company submitted its initial primary objections to the determined rate. Its main objections are detailed below:

(1) Non-Recognition of the Construction costs of the generation units The decision of the Electricity Authority reflects full non-recognition of the Company's

costs, since the normative recognition of construction costs is significantly lower than the actual construction costs throughout the construction process, even for units that already commenced operation, where construction costs have been recorded in the books. Consequently, there is a gap of approximately NIS 2.1 billion between costs recognized by the Electricity Authority and the cost as estimated by the Company,



11


3) The Effect of the new rate base on the financial statements of the Company (continued) which includes both costs expended up to December 31, 2009 and costs expected for

completing the generation units from this date onwards. Deficient coverage will cause the Company to write off considerable assets. Such a step has extensive repercussions, particularly since the assets are largely financed by foreign capital. Moreover, non-recognition of the full costs of the emergency projects, which the Company undertook to execute within tight timetables and at considerable costs, for the purpose of preventing expected electricity shortage in the Israeli economy.

The new rate base also states that in the event that in the opinion of the Company excessive costs are created by units under construction, that are not included in the normative cost base determined by the Electricity Authority, the Company may request the Electricity Authority to recognize these costs in the subsequent annual update, after the actual operation of the unit.

Estimated volume of the non-recognized assets*

Sum (NIS billion) With respect to investments in assets operated up to December 31, 2009................................................................................................................

0.5

With respect to investments in assets to be operated in the first quarter of 2010

0.1

With respect to assets that will be operated after the first quarter of 2010 (including an estimated cost of assets under construction)...................

1.5

Total ............................................................................................................... 2.1 * This estimate does not include pension costs of approximately NIS 350 million,

that were not included in the rate recognition as yet, because the Electricity Authority did not completed its audit of pension costs of Company employees. Upon completion of this audit and in accordance with its results, the Electricity Company intends to amend the recognized costs. The Company estimates that these costs will be recognized, since these costs are an integral part from the assets construction costs.

The Company estimates that it will write off approximately NIS 0.6 billion in the first quarter of 2010, with respect to the investments in assets coverage shortage for assets that will be operated up to the end of the first quarter of 2010. As for the recognition shortage of the other assets of approximately NIS 1.5 billion, the Company did not yet complete review of the assets writing off mode and rate according to the investment rate in assets.

(2) Fines for failing to meet timetables - The Electricity Authority defined various fines with respect to failure to meet normative timetables for commencing operation of new generation units. The Electricity Authority is fully aware of the fact that these fines are based on timetables that are already unrealistic, therefore, it is certain that the Company will be charged with fines arising from the delays, regardless of the factors delaying the construction processes. In addition, the Company is of the opinion that the Electricity Authority is not authorized by law to impose fines, all the more so when the defined fines are tendentious, unreasonable and non-proportional.



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3) The Effect of the new rate base on the financial statements of the Company (continued) Estimated fines with respect to assets, applied up to the end of the first quarter of 2010,

is approximately NIS 25 million. The Company estimates that it will deduct this sum in the first quarter of 2010. Estimated fines with respect to assets applied after the first quarter of 2010 is expected to amount to approximately NIS 1,259 million. The Company will did not yet complete review the recognition of the fines mode and rate, according to the projects progress rate.

The Company estimates that is did not exhaust its full rights and claims. Therefore the aforementioned sums are the best available estimate as of the report date and may change.

(3) Use of an outdated sales forecast - The Electricity Authority prevents the Company from collecting the recognized cost it itself determined. The Electricity Authority chose an obsolete and outdated demands forecast, while being fully aware of the fact that this forecast is considerably higher that the current demand forecast, due to the effect of the financial crises. Using a demand forecast without considering the actual demand curve is unreasonable, since there is no logic in preventing the Company from colleting the full recognized cost, as determined by the Electricity Authority.

(4) The hedging Mechanism – The Electricity Authority decided to end the old hedging mechanism and return the debt to the consumers, spread over five years. The Company is still studying the implications of this decision.

(5) Non-Recognition of half the spare parts inventory costs - For the purpose of

supplying electricity at high reliability and availability, the Company holds a stock of spare pares for current maintenance, planned renovations and faults repair. The Electricity Authority decided to recognize only half the recognized annual cost, about NIS 30 million, with respect to spare parts inventory capital, claiming that "it did not receive the information on inventory required for costs review". For the purpose of supplying electricity at high reliability and availability, the Company holds a stock of spare pares for current maintenance, planned renovations and faults repair. The Electricity Authority elected to deny recognition of half the recognized inventory costs, despite detailed explanations from the Company. The Company is still studying the effect of this decision on the financial statements.

(6) Conversion to Gas cost – Recognition of conversion to gas costs is applied only to gas operated units. Moreover, only investments made one year after the operation date will be recognized, provided that the investments will not exceed 10% of the total erection cost. Regarding units that already operate with gas, the Electricity Authority, requests the Company to explain the excessive costs for the purpose of receiving full recognition (Gezer Site).

(7) Operational salaries cost - The Electricity Authority chose to link the salaries of Company employees to the general salaries index, while being aware that a real erosion of 10% was recorded in this index from 2006 to 2010, thereby adversely affecting the Company by its adoption. The logic of this linkage is impaired, since the Company has collective salaries agreements, which were approved by the Supervisor of Wages and Work Agreements in the Ministry of Finance and are not linked in one way or another to the general salaries index.



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3) The Effect of the new rate base on the financial statements of the Company (continued)

(8) Gas incentive - The Electricity Authority strongly indicated that the new rates book

includes an incentive for expanding the use of natural gas. However, this decision is misleading and devoid of meaning, since the mechanism determined by the Electricity Authority does not provide any actual incentive, thereby completely ignoring the long term reduction in costs per kWh brought by the gas agreements of the Company. In fact, the Company is damaged by introducing the new technology and the extensive benefits to the economy, due to the faults curve arising from introducing new equipment and the high operational risks taken by the Company relating to these changes. The method of the Electricity Authority, which does not recognize the extra cost incurred by the Company due to the introduction of the new technology, causes unfair and unreasonable lack of rate coverage. The formula set by the Electricity Authority did not leave the Company any incentive for 2009.

(9) Rate Coverage for past debts – The new rate base does not include any reference to the subject of past claims for rate coverage of the Company for which the Electricity Authority appointed a reviewing committee.

In light of the aforementioned, the CEO of the Company sent a letter on March 7, 2010 to the

Electricity Authority requesting it to discuss, again, the determined rate base, after the Company will be granted the opportunity to respond in detail to all the problems and faults in the published rates outline, to effect a thorough amendment of the decision.

4) New Criteria for Relations of the Company with Private Electricity Producers

An update was published on July 2009 to chapters E - F of the criteria book, relating to private producers, infrastructure services, definition of the future structure of the electricity sector and roles of its active participants. The Company is studying the implications of the new criteria. On November 24, 2009 the Company's CEO addressed the Electricity Authority, arguing that the decision specified in chapters E - F of the criteria book gives rise to numerous issues that require decisions of and/or clarifications from the Electricity Authority before the decisions can be acted upon and that as long as the required decisions and/or clarifications are not made, the Company will not be able to implement these criteria in the present structure and will be forced to implement only parts thereof.

5) Disputes between the Company and the Electricity Authority

a. The Company expressed its opinion to the Electricity Authority, among other things, on the need to reduce the amortization factors in the rate and to recognize exogenous expenses. The Company disputes the Electricity Authority's decisions described in paragraph (b) above regarding the update of the current rate, the positions of the Electricity Authority on the implications of the new rate base for the generation segment as described in paragraph (a) above.

On April 29, 2007, the Chairman of the Company's Board of Directors approached the Ministers requesting to convene an urgent discussion in order to remove limitations and restrictions imposed on the Company with regard to raising capital, this so as to deliberate the Company's demands regarding the decisions of the Electricity Authority.

Following this appeal, several discussions were held, attended by all the relevant Government organizations, including the Electricity Authority with the intention of evaluating various ways of resolving the gamut of problems described hereunder.



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4. Disputes between the Company and the Electricity Authority (continued) On July 10, 2007, the Chairman of the Company's Board of Directors approached the

chairman of the Electricity Authority detailing a series of streamlining measures that the Company intends to take and demanded that the Electricity Authority would concurrently decide on another rate increase.

On August 8, 2007, the Electricity Authority decided to increase, as of September 8, 2007, the recognized cost by the rate of 5% (in relation to the recognized cost as of July 16, 2007). The consumer rate update will be determined after examination of the overall changes in recognized cost as of that date and in particular this increment and the changes resulting from the current update.

The increment to recognized cost was an advanced recognition of investment cost at the following terms:

1) On the date of establishing a new rate base for the generation segment or at the end of

one year from the date of effecting the increment to recognized cost (September 8, 2007), whichever is sooner, the special increment will cease. The accrued increment will be deducted from the rate bases of the recognized assets determined by the Electricity Authority.

2) Until September 8, 2007, the Electricity Authority will determine a supervision mechanism ensuring that said increment as discussed in d) 1) above will only be designated solely for financing development needs.

On November 4, 2008, the Electricity Authority announced that collection for advance

recognition of investment cost is terminated on September 8, 2008. Surplus amounts accumulated through this collection were returned to consumers under the compensation mechanism for delay in updates.

The Company recorded this increment as an offset to the investments in fixed assets under construction. The total reduction of fixed assets under construction cost with respect to this increment amounts to the sum of approximately NIS 1,037 million (of which the amount of approximately NIS 19 million has not yet been allocated to projects). Collection of this increment ended on September 8, 2008, and reduced the recognized costs at a rate of 4.76%, pursuant to collection termination.

The Company's Management and the Board of Directors are conducting an ongoing dialogue with the relevant Government bodies in an attempt to advance the discussions regarding issues in dispute as to the electricity rate. In this regard, on August 8, 2007, the Electricity Authority made the abovementioned decision in the matter of updating the rate base and in the matter of the emergency plan for the Electricity Sector, which constitutes a positive indication of the future actions of the Electricity Authority regarding the update of the rate base. In the event that this positive indication is not realized in the future, the Company's Management will be required to take significant efficiency steps, cut back on vital operating expenses and development costs and carry out structural and organizational changes in order to prevent damage to its ability to serve its debts.

b. On March 2, 2009, the Electricity Authority published its decision on the annual update for

2008. Its decision updates the recognized fuel mix for 2008 and its basic assumptions and also fuel prices. The recognized fuels basket was accordingly updated retroactively as of April 2008.



15


4. Disputes between the Company and the Electricity Authority (continued) The definition of the recognized fuels basket during the annual update for 2008 recognized

some demands of the Company, e.g., the request to recognize generation inception dates with natural gas in Gezer (except CCGT Gezer A) and Hagit and use of the actual load curve in 2008. However, the Company opposes some of the assumptions used by the Electricity Authority to define the fuels basket, as follows: • Forced unavailability of generation units and scheduled maintenance - normative

values remained at the level set by the Electricity Authority in the previous year, contrary to the Company's position.

• Non-recognition of the operation of Gezer A with fuel oil up to August 2009 (decision of the Electricity Authority stating that Gezer A operates on gas since October 2007).

• Non-recognition of the delayed completion of the steam addition in CCGT Alon Tavor. The Electricity Authority recognized the rate from September 2008. The Company is of the opinion that the actual operation date of the CCGT, namely December 2008, should be recognized.

• Gas incentive - according to the decision of the Electricity Authority, no incentive was recognized for the Company with respect to the current gas agreement. The Company is of the opinion that a gas incentive set for 2008 should also apply to current gas agreements.

c) On April 30, 2009, the Electricity Authority published its decision on the annual update for 2009, stating that updates of the fuel basket and several other components will be postponed to the date of applying a new rate base for the generation segment. Consequently, the fuels component charged to electricity consumers by the Company is still based on the mix recognized for 2008. This component is higher than the forecast rate for 2009, due to the transition to extensive use of natural gas by the generation units of the Company. In the framework of the published decision of the Electricity Authority in February 2010 on the new electricity rate, the Electricity Authority updated the recognized fuels costs in the rate retroactively from April 2009. Price differences with respect to retroactively updated gas prices were also included. In addition to updating the fuel mixture, the Electricity Authority also updated retroactively the recognized gas price in the rate, from July 2009 applied to new gas contracts entered by the Company.

The Company also estimates that the remaining rate components that were not updated in the aforementioned annual update will also be expressed retroactively from April 2009. In light of the above, the Company recorded in its books a regulatory liability with respect to the said partial rates update only for 2009. The balance of these liabilities as of the balance sheet date is NIS 1,987 million.

5. Emergency plan for the Electricity sector

On August 27, 2008, the Minister for National Infrastructures approved an addition to the general development emergency plan for the electricity sector that includes construction of three combined cycle gas turbines: at Ramat Hovav, Eshkol and Hagit (synchronization of gas turbines in July 2010 and synchronization of the steam driven addition in July 2012). These three turbines are in addition to the two gas turbines at Ramat Hovav, one of which was synchronized in November 2009 and the second was synchronized in January 2010, all in addition to the approved multi-annual development plan.

On October 30, 2008, the Electricity Authority reached a decision on financing stage A of the emergency plan, as approved by the Minister for National Infrastructures.



16


5. Emergency plan for the Electricity sector (continued) In addition, on December 28, 2008, the Minister of National Infrastructures approved the

building of a fourth combined cycle unit in Alon Tavor (stage A up to the summer of 2011, stage B, steam addition, up to summer 2013).

The main principles of the decision, as made by the Electricity Authority are:

a) Pursuant to the accelerated development needs required by the Company and mainly the emergency plan for building generation units, as decided by the Minister for National Infrastructures, and in view of the financial condition of the Company and the uncertainty in the capital markets, the Electricity Authority sets a dedicated amount for development for the years 2009 - 2010, as follows: 1) The Electricity Authority will recognize the costs for financing the development plan

in the electricity rates at an accumulated amount of NIS 2 billion. This recognition will be spread over a period of two years, starting from January 2009 and ending on January 1, 2011, or up to the end of the collection.

2) The aforementioned amount in sub-section 1 will be managed through a dedicated account, supervised by the Electricity Authority.

The plan is upon approval of the Electricity Authority. 3) The Electricity Authority will include its decision in calculations for defining the rates

base for the generation segment and will verify that no surplus payment is created when defining the rates for the Company.

b) Recognition of this amount is subject to fulfilling the detailed conditions, including attainment of the timetables for operation of the project, as follows: 1) The Company will meet the timetables for the development plan of the generation

segment, including the emergency plan, as approved by the Minister for National Infrastructures and pursuant to the stipulations of the document for a hearing, published by the Electricity Authority.

2) The CEO of the Company will report to the plenum of the Electricity Authority once every quarter on the implementation of the general development plan, including the development plan referred to in this decision, relating to meeting timetables, costs and a budget versus execution report, in a format approved by the Electricity Authority.

3) The Company will not transfer funds to the CPY Pension Fund, exceeding the monthly current provision, until examinations are completed and decisions are made by committees appointed for this purpose in the Company, in the Government Companies Authority and the review conducted by the Electricity Authority, all subject to the law.

4) The Company will act as soon as possible to execute efficiency steps which it announced to improve the financial condition of the company.

On October 31, 2008, the Board of Directors of the Company approved the emergency plan for the Electricity Sector. This approval is issued pursuant to the decision of the Electricity Authority on the aforementioned principles for financing the emergency plan. The Board of Directors of the Company approved that the Management of the Company will enter an agreement with Siemens to purchase three gas turbines and peripheral equipment. This approval comes in addition to the purchase of two gas turbines from General Electric, purchased for the Ramat Hovav site.

Total expected investment for this stage of the emergency plan is approximately NIS 3.6 billion and it will be financed as follows:

Approximately NIS 0.9 billion was received as customer credit through Siemens and approximately NIS 2 billion will be collected through the electricity rate, in accordance with the decision of the Electricity Authority and the balance will come from internal sources of the Company.



17


5. Emergency plan for the Electricity sector (continued) The Company records this rate addition, setting off from assets under construction items. As

of the balance sheet date, the Company deducted the balance of the assets under construction item with respect to this addition in the amount of NIS 951 million. c. Pursuant to the decision of the Electricity Authority of October 30, 2008, the CEO of the

Company also submits a quarterly report to the Electricity Authority. Accordingly, the Company submits current reports of projects progress. The report submitted on June 15, 2009, noted delays in operation dates. The decision of the Electricity Authority of June 29, 2009 states that in the event that the Company fails to attain the timetables stipulated in the emergency plan for commercial operation of the aforementioned power stations included in it, the Company will be penalized as follows: 1) Regarding each of the two power stations at Ramat Hovav, included in the emergency

plan for the summer of 2009, which the Company undertook to operate up to and no later than July and August 2009: a) For each month of delay in the commercial operation compared to the scheduled


b) Moreover, and without derogating the aforementioned in paragraph (a), a sum amounting to one fifth of the total dedicated amount will be deducted in the event of an additional delay in the commercial operation of each of the two aforementioned power stations beyond June 30, 2010. In the event that such a deduction will result in a debt to the consumers, the Electricity Authority will determine the mechanism and period for repaying this debt.

2) Regarding each of the three power stations (gas turbines in Eshkol, Ramat Hovav and Hagit sites) included in the emergency plan for the summer of 2010, which the Company undertook to operate up to and no later than July 2010: a) For each month of delay in the commercial operation compared to the scheduled


b) Moreover, and without derogating the aforementioned in paragraph (a), a sum amounting to one fifth of the total dedicated amount will be deducted in the event of an additional delay in the commercial operation of each of the three aforementioned power stations beyond June 30, 2011. In the event that such a deduction will result in a debt to the consumers, the Electricity Authority will determine the mechanism and period for repaying this debt.

3) The aforementioned costs deducted by the Electricity Authority will be presented as

an expense in the statement of operations of the Company, with proper disclosure.

In its letter of March 9, 2010, the Electricity Authority stated that the determining date for meeting timetables is the synchronization date and not the commercial operation date.

As of the balance sheet date, the Company made a provision of approximately NIS 75 million with respect to aforementioned deduction of recognized costs. The Company disagrees with the Electricity Authority on this deduction.



18


6. Unresolved Subjects between the Electricity Authority and the Company: Estimate and volume of the sums are before the effect of the restatement. This restatement has no material effect on the estimated financial amounts

Subject Electricity Authority’s Decision Company’s Position Estimated

Financial Volume Amortization Coefficients

The Authority has placed amortization coefficients starting April 2004 at the following cumulative annual rates: 2.1% for generation, 1.3% for transmission, 2.5% in high voltage distribution and 3.7% for low voltage distribution. A decision was made not to award retroactive compensation for previous years in which amortization coefficients were not reduced.

Unreasonable efficiency coefficients, applied to the Company for many years, significantly affect its revenues. Throughout the years, the Electricity Authority did not present any explanation or justification to the amortization coefficient it defined. The decrease applied by the Authority in April 2004 was too little and too late. The position of the Company, backed up by and based on consultants studies, is that a 2% amortization coefficient should be applied to the operational component only and also to receive retroactive compensation for previous years, for which the amortization coefficients were not reduced.

NIS 11,000 million for the years 1996-2008. (In December 2008 prices).

Fuels basket - forced unavailability values

Uses forced unavailability values and maintenance days lower than those accepted worldwide, and in some cased even lower than the actual performance of the Company to calculate fuel baskets recognized in the electricity rate of the Company.

The Company believes that unavailability values and maintenance days for the calculation of fuel mixtures must be based upon long term normative parameters, which will allow the Company to enjoy the fruits of efficiency in operating the system

NIS 2,800 million for the years 2003-2007 (in current prices)

Fuels basket - Gas Incentive rate of fuel costs savings retained by the Company as a result of the use of natural gas

The Authority set an incentive path for the Company in June 2002 for the years 2003 - 2006 only. The authority did not allow any gas incentive to the Company in the years 2007 - 2009. The new rate base for the generation segment, published in February 2010, gas incentive will be granted to new gas transactions for the years 2009 to 2012. The formulas, as set by the Electricity Authority does not grant any incentive to the Company for 2009.

The Company believes that it has achieved significant savings thanks to its efforts on the natural gas subject and therefore requests to receive a permanent 20% incentive out of the total savings realized by use of natural gas, and that the rate formula should be calculated from the actual operation date of the generation unit, du to the high uncertainty related to gas delivery date to the site and to the inclusion of the Egyptian supplier in the system, continuing throughout the life span of the units operated with natural gas. As an alternative, the Company requested to receive an incentive for new gas agreements with a multi-annual aspect..

Total saving for the economy for the years 2004 – 2009 is approximately NIS 23,500 million of which NIS 1,078 million were granted to the Company as an incentive. (in current prices)



19


6. Unresolved Subjects between the Electricity Authority and the Company: (continued)


Financial Volume Fuels Basket Mix for the year of 2007

The Authority refused to recalculate the recognized fuels basket for this year. The Authority stated in the new rate base that the fuels basket will be retroactively updated each year according to the actual demand curve. The Authority does not intend to apply the mechanism for the fuel basket in 2007.

The Company claims that a significant change occurred between the original 2007 demand prediction and the actual demand, and as a result the Company’s fuel mixture changed materially (use of expensive fuels - diesel and crude). The Company has requested a recalculation of the recognized fuel basket by the Authority, since the Company incurred a loss of income.

NIS 690 million in 2007 (in current prices)

Fuels Basket - postponement in converting power stations to natural gas and using more expensive fuel Gezer Combined Cycle A

In the annual update for 2007, the Authority stated, as part of the basic assumptions for the 2007 fuel mixture calculation, that the Gezer A station will begin operating with natural gas in mid October 2007. In its decision from March 2009 on the recognized fuels basket for 2008 (in the annual update for 2008), the Electricity Authority used this assumption again.

Gezer Combined Cycle A station started operating with gas in July 2008. The Company requests compensation for operating the station with crude (a more expensive fuel) during the period October 2007 to July 2008, especially where the reasons for the delays were events out of the Company's control..

NIS 1.2 billion for the years 2007 and 2008 (in current prices)

Fuels basket - postponed conversion of power stations to natural gas and use of more expensive fuel - Reading Power Station

The fuels mix, recognized for the 2005 fuel basket, was calculated assuming that the Reading Station will be powered by natural gas and in May 2005.

In 2005, the power station was actually powered by crude only, which is a more expensive fuel, due to reasons beyond the Company’s control. In practice, the station started operation with natural gas in the second half of 2006. Consequently the Company incurred additional costs that were not covered by the electricity rate, for which the Company requests to receive rate coverage.

NIS 275 million for 2005 (in current prices)

Fuels Basket - Reading Power Station - Closed by order of the Ministry of Environment

The Authority denied the application of the Company to recognize the loss of income caused to the Company as a result of implementing the order to close the station from March to June 2006.

The station was closed from March to June 2006 by an order of the Ministry of the Environment. From the closing date, the Company was forced to produce electricity at alternate stations using a more expensive fuel mixture, using among others, diesel operated power stations, to avoid any disruption in power supply to consumers. Consequently, the Company incurred loss of income. The Company requests to receive rate coverage for this loss of income.

NIS 170 million for 2006 (in current prices)



20




Financial Volume Loss From Collection of the Average Rate

In the rate base published in 2002, the Authority set an income which the Company is entitled to collect from the public for the purpose of covering its expenses.. To date, the Authority has not responded to these requests and has not corrected the makeup of the rate.

For reasons beyond the Company's control, stemming mainly from changes in electricity consumption habits of the public, influenced by the indication of the current rates, the Company failed to collect the full income as defined by the Authority and therefore, did not cover its expenses. The Company appealed to the Authority to amend the rate structure, while compensating for years in which the Company did not collect the full recognized income.

NIS 953 million for the years 2000-2008. (in current prices)

Exogenous Expenses

In 1998, the Electricity Authority set a mechanism for annual recognition of exogenous expenses in the electricity rate. In 2005, the Electricity Authority published a decision that canceled the mechanism established for recognition of exogenous expenses. In April 2007, the Electricity Authority forwarded the position of its professional experts team that includes a new mechanism for recognizing future exogenous expenses.

The Company submitted calculation for recognition of the expenses each year. The Company requests to receive rate coverage for the full exogenous expenses it incurred until the Authority, canceled the recognition mechanism. The Company submitted in April 2006 a proposal to the Electricity Authority for an alternative recognition mechanism in significant exogenous expenses it will incur in future including differentiation between operational cost and investment coste.

NIS 950 million for the years 2002-2008 (in December 2008 prices)

Financing Costs

In 2002, the Authority recognized in the electricity rates cost related to funds raising costs in Israel, based on State bonds for 10 years with an added margin of 0.73% and on fund raising costs abroad, based on U.S.A., State bonds for 10 years with an added margin of 2.4%. These margins were not updated since 2002.

The Company raised (and is expected to raise in future) foreign capital at volumes amounting to billions NIS each year, mainly for financing its development plans. Fund raising costs in Israel and abroad, was higher in recent years (and actually throughout the test period) than costs recognized by the Authority (margin of the last funds raising in Israel was 4.35% and 6.84% abroad), causing loss of income to the Company. The Company requests recognition of all financing costs it actually incurred with respect to funds raised during the test period.

NIS 282 million for the years 2002-2008. (in current prices)



21




Financial Volume Electric Consumption in Company Facilities

The Authority rejected the Company’s claim that power consumption at the Company’s facilities is not included in the recognized income of the Company. The Authority claims that power consumption cost at Company's facilities is part of the Company's recognized operating costs and the Company should budget these cost under the total sum of its recognized operational costs.

The Company receives rate recognition in the electricity consumption of Company facilities used for its routine operation. As shown by audits of the current calculation method of the electricity rate, conducted by the Company, the electricity consumed by Company facilities is excluded from the recognized income of the Company, since the required income is divided by the total electricity consumption of the Israeli market that includes the electricity consumption of Company facilities.

NIS 180 million for the years 2002-2008 (in current prices)

Alon Tavor CCGT

The rate update for 2008, implemented in March 2009, set the operation commencing date of Alon Tavor CCGT with diesel as September 2008. The Electricity Authority did not recognize the delay in completing the steam addition, caused by employees sanctions.

The Company disputes the decision of the Electricity Authority, since the delay was caused by events on which the Company had no control. Therefore, the Electricity Authority had to recognize the actual operation commencing date of the CCGT, namely, December 2008.

NIS 50 million (in current prices)

In addition, the Electricity Authority did not reach a decision on several material subjects (see details below) that caused a significant damage to the Company's income over the years.

Subject Electricity Authority’s Position Company’s Position Estimated Financial Volume

Expenses Due to Pension Liabilities

The Electricity Authority did not yet reach a decision on the subject. The Electricity Authority established a committee in 2004 to discuss this issue. This committee suspended its operations at a certain stage. In the document for the hearing on the new rate base for the generation segment, it indicated that its work to review pension costs of Company employees was not completed as yet and that it intends to complete the review during the approaching period and submit it to a public hearing so that pension costs will be reflected in the final decision on the new rates bases of the generation segment. In its decision on the new rate base for the generation segments, the Electricity Authority noted that after the publication of this decision, it intends to publish for a public hearing principles and general guidelines for recognizing pension costs of generation A, B and C employees starting on 1996 and issue its final decision in 2010.

Significant changes in calculation rules of actuarial liabilities beginning from 2003, as determined by the Commissioner of the Capital Market, Insurance and Savings of the Ministry of Finance, the Company was obliged to record high expenses amounts in its statements of operation that did not have a rate coverage since these were not included in the rate base. Then, upon adopting the principles of the International Accounting Standard 19 (IAS 19), considerable amounts were charged as actuarial losses which were not yet amortized and which are not recognized in the electricity rate as well. The Company believes that rate coverage should be granted to the full debt, arising from spreading the actuarial changes according to IAS 19.

NIS 2.93 billion as of December 31, 2007



22



Subject Electricity Authority’s Position Company’s Position Estimated Financial Volume

Delays in updating rate bases for the different segments and changes in the order of setting them

In its December 2005 decision the Authority noted that it first intends to set a new rate for the generation system, followed by the distribution system and only at the end for the transmission system. On July 30, 2008, the Authority published a decision on the new rate base for the generation segment only (in February 2010), but not for the other segments. Electricity Authority did not compensate the Company with respect to failure to update the rate base for the generation segment in previous years.

The Company believes that determining the order of the rates is important. Actually determining the rate first for the generation segment which is the most profitable and lastly for the transmission segment that loses the most is incorrect as it is necessary to begin with segments with an accumulated deficit of costs coverage (distribution and transmission). In addition, the Company incurred a significant loss of income due to the prolonged delay (over four years) in updating the rate base.

NIS 1,500 million for each of the years 2006 - 2008. In December 2007 prices.

Despite the commitment of the Electricity Authority (a commitment that caused the Electricity Authority to appoint a dedicated team to this purpose), it did not address these issues in its decision on the new rate base for the generation segment.



23

1. Business Position of the Corporation (continued) E. Financial Condition 1. Comparison of the financial position on December 31, 2009 to the position on December 31,

2008 The amounts presented below are after the restatement a. Total current assets as of December 31, 2009 amounted to NIS 9,861 million compared to

NIS 11,239 million as of December 31, 2008. A decrease in the amount of NIS 1,378 million. This decrease in the balance of current assets as of December 31, 2009 compared to December 31, 2008 derives mainly from a decrease in fuels inventory.

Details of the current assets are as follows: The total sum of cash and cash equivalent balance as of December 31, 2009 is NIS 3,885

million compared to NIS 3,670 million as of December 31, 2008. An increase in the amount of NIS 215 million.

Sum total of trade receivables balances as of December 31, 2009 is NIS 3,219 million compared to NIS 3,487 million as of December 31, 2008. A decrease in the amount of NIS 268 million.

Sum total of accounts payable balances as of December 31, 2009 is NIS 875 million, compared to NIS 950 million as of December 31, 2008. A decrease in the amount of NIS 75 million.

Sum total balance of fuels inventory as of December 31, 2009 is NIS 1,659 million compared to NIS 2,898 million as of December 31, 2008. A decrease in the amount of NIS 1,239 million.

Sum total balance of warehouses inventory as of December 31, 2009 is NIS 223 million compared to NIS 234 million as of December 31, 2008. A decrease in the amount of NIS 11 million.

b. 1. The Company holds amounts in a trust account with respect to additional pension liabilities, the balance of which as of December 31, 2009 is approximately NIS 1,736 million compared to NIS 1,591 million in the same period last year (for additional details, see Note 10 to the Financial Statements).

2. The sum total of investments in fixed assets for the reporting period amounted to approximately NIS 3,936 million, net, after offsetting consumer participation amounting to approximately NIS 951 million, compared to approximately NIS 2,843 million for the same period last year, after offsetting consumers participation amounting to NIS 725 million, an increase of approximately NIS 1,093 million, a rate of approximately 38%.

Cumulative investments in the period were as follows: In power stations, combined cycle gas turbines and buildings a total of approximately

NIS 2,500 million, in sub-stations and high voltage lines a sum of approximately NIS 502 million, in grids (with receipts deducted) a sum of approximately NIS 686 million net, after consumers participation in construction of fixed assets in a sum of approximately NIS (951) million, in other investments a sum of approximately NIS 398 million as well as an increase in long term storage capacity in a total of approximately NIS 801 million.

c. The balance of current liabilities as of December 31, 2009 is NIS 8,058 million, compared to NIS 11,146 million as of December 31, 2008. A decrease of approximately NIS 3,088 million.

Details of the current liabilities are as follows: Total sum of credit from banking corporations and from other credit providers as of

December 31, 2009 is NIS 1,727 million compared to NIS 6,705 million as of December 31, 2008. A decrease, in the amount of NIS 4,978 million .

Total sum of suppliers and service providers as of December 31, 2009 is NIS 1,457 million compared to NIS 1,376 million as of December 31, 2008. An increase in the amount of NIS 81 million.

Total sum of accounts payable as of December 31, 2009 is NIS 1,372 million compared to NIS 1,813 million as of December 31, 2008. A decrease in the amount of NIS 441 million.

Total sum of regulatory liabilities net as of December 31, 2009 is NIS 2,258 million compared to NIS 128 million as of December 31, 2008. An increase in the amount of NIS



24

1. Business Position of the Corporation (continued) E. Financial Condition (continued) 1. Comparison of the financial position on December 31, 2009 to the position on December 31,

2008 (continued) 2,130 million.

Total sum of advance payment from customers less work under execution as of December 31, 2009 is NIS 441 million compared to NIS 307 million as of December 31, 2008. An increase in the amount of NIS 134 million.

Total provisions balance as of December 31, 2009 is NIS 803 million compared to NIS 817 million as of December 31, 2008. A decrease in the amount of NIS 14 million.

d. On December 31, 2009, the Company had non-current net liabilities equaling approximately NIS 54,632 million that include debentures, liabilities to banking corporations and others equaling approximately NIS 42,465 million (see details in section 5 d below) as detailed herein: NIS 23,585 million in foreign currency, NIS 16,872 million index linked, NIS 944 million unlinked and hedge agreements (foreign currency – swap and forward contracts) amounting to approximately NIS 1,064 million. Of the Company’s foreign currency liabilities listed above: NIS 17,223 million in USD, NIS 3,148 million in Euros, NIS 3,201 million in Japanese Yen, NIS 8 million in Swiss Francs and NIS 5 million in Pounds Sterling.

The Company also has debentures to the State of Israel equaling approximately to NIS 2,338 million. The Electricity Authority decided to transfer the real exposure to the currencies basket, amounting to approximately NIS 13.2 billion (net after efficiency steps), out of these liabilities of the Company, to the electricity consumers and to the creation of a regulatory asset/liability for the financial expenses. The Company is exposed to real changes in currency rates for its liabilities except when such exposure is transferred to the consumers as above and when they are used for construction with financial expenses being capitalized to fixed assets. So as to minimize this exposure, the Company has entered into the following hedge transactions: 1) Swap Transactions

Purchase of: In Millions of NIS U.S. Dollar 5,988 Euro 730 Yen 2,189 Pounds Sterling 379 9,286

In Return for : Linked NIS 6,298 NIS 1,011 Euro 1,637 Pounds Sterling 1,046 U.S. Dollar 242 10,234

As a result, as of the balance sheet date, the Company had long term credit balances for these transactions, amounting to approximately NIS 948 million (before current maturities equaling NIS 93 million). b. Forward contracts: USD - NIS contracts - a volume of NIS 668 million. NIS - USD contracts - a volume of NIS 358 million. NIS - Euro contracts - a volume of NIS 272 million. The Company does not have long term balances with respect to the aforementioned forward contracts.



25


2008 (continued) e. The Company holds sums to cover its pension-related liabilities in a central provident fund

for a “stipend” ("CPY"), the balance of which is approximately NIS 19,027 thousand as of December 31, 2009, compared to NIS 17,410 thousand in the corresponding period last year.

f. The balance of deferred taxes as of December 31, 2009 amounted to approximately NIS 3,894 million compared to NIS 4,968 million as of December 31, 2008. A decrease of NIS 1,074 million.

g. The shareholders’ equity as of December 31, 2009 amounted to approximately NIS 16,829 million compared to NIS 15,591 million as of December 31, 2008. An increase of NIS 1,238 million.

h. Sensitivity Analyses Total lines of sensitivity analyses, as presented in Note 27 to the Financial Statements are

presented below: (1) As of December 31, 2009 Loss (profit)

from increase in market factor

Balance as of December 31,

2009

Loss (profit) from decrease in

market factor Change in currency rate in % 10% 5% 5% - 10% - NIS in millions 1. Analysis of foreign currency

sensitivity

Loans and debentures per currency 2,483 1,242 42,800 (1,242) (2,483) Swap transactions )636( )318( 948 318 636 Forward transactions 58 29 (52) (29) (58) 2. Interest rate sensitivity analysis (5) (2) 43,696 3 7 (2) As of December 31, 2008 Loss (profit)



2008



sensitivity

Loans and debentures per currency 2,859 1,431 46,300 (1,431) (2,859) Swap transactions )719( (359) 579 359 719 Forward transactions )358( )179( (165) 179 358 2. Interest rate sensitivity analysis (21) (11) 46,714 11 21



26


2008 (continued)

(3) As of December 31, 2007 Loss (profit)



2009



sensitivity

Loans and debentures per currency 2,537 1,267 43,030 (1,267) (2,537) Swap transactions (540) (270) 1,401 270 540 Forward transactions (9) (4) 12 4 9 2. Interest rate sensitivity analysis 1 1 44,443 (0) 2

i. Financial Condition by Electricity Chain Segments 1) Current assets for the generation segment as of December 31, 2009 amounted to

approximately NIS 6,466 million, largely deriving from trade receivables due to the sale of electricity amounting to approximately NIS 2,469 million (this section is attributed to segments according to the ratio of revenues), fuel inventory (attributed to the generation segment) amounting to approximately NIS 1,659 million and from a balance of cash and cash equivalents of approximately NIS 1,831 million. For the transmission segment, current assets amounted to approximately NIS 1,437 million and for the distribution segment approximately NIS 1,958 million, deriving mainly from trade receivables due to electricity sales and from balances of cash and cash equivalents.

2) Net fixed assets as of December 31, 2009 amounted for the generation segment to approximately NIS 29,375 million, for the transmission segment approximately NIS 14,326 million and approximately NIS 16,836 million for the distribution segment. Direct assets were attributed to the appropriate segments; joint assets (some 2.83% of the Company’s assets) were divided according to a distribution key that the Company assesses to be a reasonable estimate for attributing these assets. During the period covered by the report, the Company invested a total of approximately NIS 2,500 million, approximately NIS 550 million and approximately NIS 730 million in direct assets in the generation, transmission and distribution elements, respectively. In addition, a sum of approximately NIS 156 million was invested in joint property.

3) a) As of December 31, 2009, long term loans and debentures (debentures, liabilities to banking corporations and others, and others) for the generation segment totaled approximately NIS 24,017 million, for the transmission segment approximately NIS 9,612 million and for the distribution segment approximately NIS 11,174 million. Long term loans and debentures were mainly attributed according to the distribution ratio of fixed assets to the segments and according to the manner of financing the Company’s assets according to the rate principles.

b) Net liabilities deriving from severance pay were attributed to segments according to current salary ratios in operations and totaled approximately NIS 1,306 million for the generation segment, approximately NIS 174 million for the transmission segment and approximately NIS 977 million for the distribution segment.

4) The current ratio as of December 31, 2009 for the generation segment is 1.48, for the transmission segment 1.23 and 0.78 for the distribution segment.

5) The ratio of the sum of liabilities to shareholders’ equity as of December 31, 2009 is 4.18 for the generation segment, 3.26 for the transmission segment and 3.36 for the distribution segment.



27


2008 (continued) 6) Capital yield in annual terms (calculated according to capital at the end of the period) is

positive at a rate of approximately 4.53% on capital in the generation segment, in the transmission segment negative yield of approximately 0.26%, in the distribution segment negative yield of approximately 4.38%.

2. Comparison of the financial position on December 31, 2008 to the position on December 31,

2007

The amounts presented below are after the restatement a. Total current assets as of December 31, 2008 amounted to NIS 11,239 million compared to

NIS 7,421 million in December 31, 2007. An increase in the amount of NIS 3,818 million. This increase in the balance of current assets as of December 31, 2008 compared to December 31, 2007 mainly derives from an increase in cash and cash equivalents.

Details of the current assets are as follows: The total sum of cash and cash equivalent balance as of December 31, 2008 is NIS 3,670

million compared to NIS 492 million as of December 31, 2007. An increase in the amount of NIS 3,178 million.

Sum total of trade receivables balances as of December 31, 2008 is NIS 3,487 million compared to NIS 3,302 million as of December 31, 2007. An increase in the amount of NIS 185 million.

Sum total of accounts payable balances as of December 31, 2008 is NIS 950 million, compared to NIS 968 million as of December 31, 2007. A decrease in the amount of NIS 18 million.

Sum total balance of fuels inventory as of December 31, 2008 is NIS 2,898 million compared to NIS 2,426 million as of December 31, 2007. An increase in the amount of NIS 472 million.

Sum total balance of warehouses inventory as of December 31, 2008 is NIS 234 million compared to NIS 233 million as of December 31, 2007. An increase in the amount of NIS 1 million.

b. 1. The Company holds amounts in a trust account with respect to additional pension liabilities, the balance of which as of December 31, 2008 is approximately NIS 1,591 million compared to NIS 1,202 million in the same period last year (for additional details, see Note 10 to the Financial Statements).

2. The sum total of investments in fixed assets in 2008 amounted to approximately NIS 2,843 million, net, after offsetting consumer participation amounting to approximately NIS 725 million, compared to approximately NIS 2,958 million for the same period last year, after offsetting consumers participation amounting to NIS 145 million, a decrease of approximately NIS 115 million, a rate of approximately 4%.

c. The balance of current liabilities as of December 31, 2008 is NIS 11,146 million, compared to NIS 7,784 million as of December 31, 2007. An increase of approximately NIS 3,362 million.

Details of the current liabilities are as follows: Total sum of credit from banking corporations and from other credit providers as of

December 31, 2008 is NIS 6,705 million compared to NIS 2,397 million as of December 31, 2007. An increase, in the amount of NIS 4,308 million .

Total sum of suppliers and service providers as of December 31, 2008 is NIS 1,376 million compared to NIS 2,104 million as of December 31, 2007. A decrease in the amount of NIS 728 million.



28


2007 (continued) Total sum of accounts payable as of December 31, 2008 is NIS 1,813 million compared to

NIS 1,587 million as of December 31, 2007. An increase in the amount of NIS 226 million. Total sum of regulatory liabilities, net, as of December 31, 2008 is NIS 128 million compared

to NIS 687 million in December 31, 2008. A decrease in the amount of NIS 559 million. Total sum of advance payment from customers less work under execution as of December 31, 2008 is NIS 307 million compared to NIS 254 million as of December 31, 2007. An increase in the amount of NIS 53 million.

Total provisions balance as of December 31, 2008 is NIS 817 million compared to NIS 755 million as of December 31, 2007. An increase in the amount of NIS 62 million.

e. On December 31, 2008, the Company had non-current net liabilities equaling approximately NIS 54,498 million that include debentures, liabilities to banking corporations and others equaling approximately to NIS 41,494 million (see details in section H(4) below) as detailed herein: NIS 23,147 million in foreign currency, NIS 16,621 million index linked, NIS 985 million unlinked and hedge agreements (foreign currency – swap and forward contracts) amounting to approximately NIS 741 million. Of the Company’s foreign currency liabilities listed above: NIS 16,367 million in USD, NIS 3,076 million in Euros, NIS 3,675 million in Japanese Yen, NIS 20 million in Swiss Francs and NIS 8 million in Pounds Sterling.

The Company also has debentures to the State of Israel equaling approximately to NIS 2,341 million. The Electricity Authority decided to transfer the real exposure to the currencies basket, amounting to approximately NIS 16 billion (net after efficiency steps), out of these liabilities of the Company, to the electricity consumers and to the creation of a regulatory asset/liability for the financial expenses. The Company is exposed to real changes in currency rates for its liabilities except when such exposure is transferred to the consumers as above and when they are used for construction with financial expenses being capitalized to fixed assets. So as to minimize this exposure, the Company has entered into the following hedge transactions: 1) Swap Transactions

Purchase of: In Millions of NIS U.S. Dollar 6,009 Euro 1,330 Yen 2,144 Pounds Sterling 399 9,882

In Return for : Linked NIS 6,655 NIS 1,115 Euro 1,521 Pounds Sterling 935 U.S. Dollar 235 10,461

As a result, as of the balance sheet date, the Company had long term credit balances for these transactions, amounting to approximately NIS 579 million (before current maturities equaling NIS 109 million).



29


2007 (continued) b. Forward contracts: USD - NIS contracts - a volume of NIS 3,439 million. The Company does not have long term balances with respect to the aforementioned forward contracts.

e. The Company holds sums to cover its pension-related liabilities in a central provident fund

for a “stipend” ("CPY"), the balance of which is approximately NIS 17,410 thousand as of December 31, 2008, compared to NIS 18,016 thousand as of December 31, 2007.

f. The balance of deferred taxes as of December 31, 2008 amounted to approximately NIS 4,968 million compared to NIS 4,751 million as of December 31, 2007. An increase of NIS 217 million.

g. The shareholders’ equity as of December 31, 2008 amounted to approximately NIS 15,591 million compared to NIS 14,821 million as of December 31, 2007. An increase of NIS 770 million.

F. Operating Results

1. Comparing Operating Results of Year 2009 to Year 2008

The amounts presented below are after the restatement

a) Net revenues from the sale of electricity for the reporting period for the sale of 48,947 million kWh, totaled approximately NIS 18,486 million, compared to approximately NIS 24,000 million for the sale of 50,161 million kWh for the same period the previous year. This consists of an approximately NIS 5,514 million decrease in revenues, a decrease of approximately 22.98%. The peak of electric demand for the reporting period was in July 2009, reaching 10,040 megawatts, where the available standard capacity at the time being 11,010 megawatts, compared to the peak demand in January of the previous year of 10,200 megawatts, the available standard capacity then being 10,730 megawatts. The change in revenues noted above derives from two reasons, which are: - A decrease of approximately NIS 4,933 million as a result of a real decrease in

average income per kWh (a decrease of approximately 20.56% compared to an increase of approximately 14.10% for the same period the previous year).

- A decrease of approximately NIS 581 million as a result of a decrease in consumption (a decrease of approximately 1,214 million kWh, which constitutes a decrease of approximately 2.42% compared to an increase of approximately 1.70% for the same period the previous year).

As a result of consumers moving to time load rates for high and premier voltage supply due to changes, especially among the larger consumers, in consumption habits over recent years as well as flexibility given to electricity consumers in changing their consumption hours, therefore revenues from consumers fail to cover the income that is required, and a loss was created from collecting the rate.

b) Depreciation and amortization expenses presented in the statement of operations for the reporting period equaled approximately NIS 3,896 million compared to a total of approximately NIS 3,784 million for the same period the previous year, which constitutes an increase of approximately NIS 112 million. This increase derives from additional investments.



30

1. Business Position of the Corporation (continued) F. Operating Results (continued)

1. Comparing Operating Results of Year 2009 to Year 2008 (continued)

c) The cost of fuel consumed (without the salary component) for the reporting period amounted to a sum of approximately NIS 8,674 million, and a sum of approximately NIS 8,788 million (including the salary component) compared to approximately NIS 12,825 million (without the salary component) and a sum of approximately NIS 12,953 million (including the salary component) for the same period the previous year. A decrease of approximately NIS 4,151 million (without the salary component) and of approximately NIS 4,165 million (with the salary component), which constitutes a decrease of approximately 32.37% (without the salary component) and approximately 32.15% (with the salary component), is largely explained as follows: 1. A decrease in the cost of diesel fuel consumed due to a real price decrease amounting

to approximately NIS 32 million, less a decrease in the cost of diesel fuel consumption of approximately NIS 2,850 million (a decrease of approximately 2.62% in the average cost per ton compared to the same period the previous year).

2. An increase in the quantity of natural gas consumed of approximately NIS 243 million, in addition to an increase in the cost of natural gas consumed, amounting to approximately NIS 361 million (an increase of approximately 19.24% in the average cost per ton compared to the same period the previous year).

3. A decrease in the cost of crude consumed amounting to approximately NIS 117 million (a decrease of approximately 32.36% in the average cost per ton compared to the same period the previous year) less a decrease in the quantity of crude consumption of approximately NIS 572 million.

4. A decrease in the cost of coal consumption due to a real price decrease amounting to approximately NIS 1,001 million (a decrease of approximately 16.31% in the average cost per ton compared to the same period the previous year) and a decrease in the amount of coal consumed equaling NIS 197 million.

d) Operating costs for the reporting period amounted to approximately NIS 16,218 million

(including depreciation and fuel and an offset of power purchased and expenses related to pensioner liabilities, hereunder “Inclusive”) and NIS 3,534 million (excluding depreciation and fuel, power purchases and expenses related to pensioner liabilities, hereunder “Non-inclusive”), compared to a total of approximately NIS 20,149 (inclusive) and NIS 3,412 million (non-inclusive) for the same period the previous year, a decrease of approximately NIS 3,931 million (inclusive) and an increase of approximately NIS 122 million (non- inclusive).

e) Profit from operating the electricity system for the reporting period amounted to

approximately NIS 3,916 million, compared to a sum of approximately NIS 5,291 million for the same period the previous year; a decrease of approximately NIS 1,375 million, which constitutes an approximate 25.99% decrease.

f) Income deriving from liabilities to pensioners, net, for the reporting period amounted to approximately NIS 206 million, compared to expenses amounting to approximately NIS 292 million for the same period the previous year, a change of approximately NIS 507 million.

g) Profit before taxes on income for the reporting period amounted to approximately NIS 176

million, compared to a sum of approximately NIS 822 million for the same period the previous year, a decrease of approximately NIS 800 million.

h) Income taxes for the reporting period amounted to approximately NIS 1,062 million income as

opposed to an approximately NIS 228 million expense for the same period the previous year, an approximate NIS 1,290 million change.



31



i) Net profit for the reporting period amounted to approximately NIS 1,238 million compared to a sum of approximately NIS 770 million for the same period the previous year, an increase of approximately NIS 468 million.

j) Financing Expenses

The increase in financing expenses for the cumulative period compared to the same period in the previous year, after capitalizing finance expenses, are as follows:

For the Year Ending Difference Sum Analysis Difference 31/12/2009 31/12/2008 NIS in millions A. Erosion of Financial Liabilities Increased financing income from the erosion of financial liabilities in foreign currency amounting to NIS 653 million net after deposits, deriving from a decrease in the real revaluation at a rate of 1.58% for the same period in the previous year to a real revaluation rate of 4.19% for the reporting period, consisting of:. Decrease in net financial income after deposits from raising capital (653) (1,115) (462) Transition from income to expenses in financing expenses from financial hedge agreements 679 234 (445) Total decrease in financing income 26 (881) (907) Decrease in financial income transferred to the regulatory liability in the reporting period according to the Electricity Authority’s decision with regard to the Company’s exposure to foreign currency due to the decrease in real revaluation of the basket to its real devaluation (476) 489 965 Decrease in financial expenses, due to changes in the known CPI, net after deposits (67) 52 119 Increase in expenses, due to erosion of the working capital items, loans and receivables 138 167 29 Total transition from financial expenses to financial income from erosion of financial liabilities (379) (173) 206 B. Other Financial Expenses Increase in interest expenses 92 2,792 2,700 Transitions from financial income to financial expenses – loans and receivables 110 11 (99) Total increase in other financial expenses: 202 2,803 2,601 Total decrease in financial expenses before capitalization (185) 2,622 2,807 C. Capitalization to Projects under Construction Decreased capitalization of designated financing expenses consisting of: Capitalization of financing income due to erosion of designated loans (10) (10) - Decreased capitalization of interest expenses on designated loans (7) 26 33 Total decreased capitalization of designated financing expenses (17) 16 33 Decrease in capitalization of undesignated financing expenses in the reporting period consisting of: Transition from capitalization of financial expenses to income due to erosion of undesignated loans (104) (67) 37 Increase in the capitalization of interest expenses on undesignated loans 102 291 189 Decrease in capitalization of undesignated financial expenses (2) 224 226 Total decrease in the capitalization of financial expenses, net (19) 240 259 Total decrease in financial expenses in the reporting period, compared to the same period in the previous year after the transfer to a regulatory asset and after capitalization of financial expenses (158) 2,390 2,548 Presented in the Financial Statements Transfer of financial expenses (income) to a regulatory asset 489 965 Finance expenses capitalization (240) (259) Other financial expenses (income) 2,141 1,842 Total financial expenses 2,390 2,548



32

1. Business Position of the Corporation (continued) F. Operating Results

2. Comparing Operating Results of Year 2008 to Year 2007

The amounts presented below are after the restatement

a) Net revenues from the sale of electricity in 2008 for the sale of 50,161 million kWh, totaled approximately NIS 24,000 million, compared to approximately NIS 20,702 million for the sale of 49,323 million kWh in 2007. This consists of an approximately NIS 3,298 million decrease in revenues, a decrease of approximately 15.93%.

b) Depreciation and amortization expenses presented in the statement of operations for the year 2008 equaled approximately NIS 3,784 million compared to a total of approximately NIS 3,655 million for the year 2007, which constitutes an increase of approximately NIS 129 million. This increase derives from additional investments.

c) The cost of fuel consumed (without the salary component) for the year 2008 amounted to a sum of approximately NIS 12,825 million, and a sum of approximately NIS 12,953 million (including the salary component) compared to approximately NIS 10,618 million (without the salary component) and a sum of approximately NIS 10,754 million (including the salary component) for the year 2007. An increase of approximately NIS 2,207 million (without the salary component) and of approximately NIS 2,199 million (with the salary component), which constitutes an increase of approximately 20.78% (without the salary component) and approximately 20.45% (with the salary component), is largely explained as follows: 1. An increase in the cost of diesel fuel consumed due to a real price increase amounting

to approximately NIS 764 million, less a decrease in the cost of diesel fuel consumption of approximately NIS 848 million (an increase of approximately 23.23% in the average cost per ton compared to the same period the previous year).

2. An increase in the quantity of natural gas consumed of approximately NIS 406 million, less a decrease in the cost of natural gas consumed, amounting to approximately NIS 101 million (a decrease of approximately 5.84% in the average cost per ton compared to the same period the previous year).

3. An increase in the cost of crude consumed amounting to approximately NIS 213 million (an increase of approximately 29.57% in the average cost per ton compared to the same period the previous year) less a decrease in the quantity of crude consumption of approximately NIS 28 million.

4. An increase in the cost of coal consumption due to a real price increase amounting to approximately NIS 2,030 million (an increase of approximately 47.14% in the average cost per ton compared to the same period the previous year) less a decrease in the amount of coal consumed equaling NIS 237 million.

d) Operating costs for the year 2008 amounted to approximately NIS 20,149 million

(including depreciation and fuel and an offset of power purchased and expenses related to pensioner liabilities, hereunder “Inclusive”) and NIS 3,412 million (excluding depreciation and fuel, power purchases and expenses related to pensioner liabilities, hereunder “Non-inclusive”), compared to a total of approximately NIS 17,869 (inclusive) and NIS 3,460 million (non-inclusive) for the year 2007, an increase of approximately NIS 2,280 million (inclusive) and a decrease of approximately NIS 48 million (non- inclusive).

e) Profit from operating the electricity system for the year 2008 amounted to approximately NIS 5,291 million, compared to a sum of approximately NIS 4,363 million for the year 2007; an increase of approximately NIS 928 million, which constitutes an approximate 21.26% increase.



33



f) Expenses deriving from liabilities to pensioners, net, for the year 2008 amounted to approximately NIS 292 million, compared to an income amounting to approximately NIS 102 million for the year 2007, a change of approximately NIS 394 million.

g) Profit before taxes on income for the year 2008 amounted to approximately NIS 998 million, compared to a sum of approximately NIS 1,101 million for the year 2007, a decrease of approximately NIS 103 million.

h) Income taxes for the year 2008 amounted to approximately NIS 228 million income as opposed to an approximately NIS 278 million expense for the year 2007, an approximate NIS 50 million decrease.

i) Net profit for the year 2008 amounted to approximately NIS 770 million compared to a sum of approximately NIS 823 million for the year 2007, a decrease of approximately NIS 53 million.



34


2. Comparing Operating Results of Year 2008 to Year 2007 (continued) j) Financing Expenses

The increase in financing expenses for the cumulative period compared to the same period in the previous year, after capitalizing finance expenses, are as follows:

For the Year Ending Difference Sum Analysis Difference 31/12/2008 31/12/2007 NIS in millions A. Erosion of Financial Liabilities Decreased financing income from the erosion of financial liabilities in foreign currency amounting to NIS 2,154 million net after deposits, deriving from a decrease in the real revaluation at a rate of 9.35% for the same period in the previous year to a real revaluation rate of 1.58% for the reporting period, consisting of:. Decrease in net financial income after deposits from raising capital 2,154 (462) (2,616) Transition from expenses to income in financing expenses from financial hedge agreements (1,137) (445) 692 Total decrease in financing income 1,017 (907) (1,924) Decrease in financial income transferred to the regulatory liability in the reporting period according to the Electricity Authority’s decision with regard to the Company’s exposure to foreign currency due to the decrease in real revaluation of the basket to its real devaluation (332) 965 1,297 Transition from income to expenses in financial expenses, due to changes in the known CPI, net after deposits 258 119 (139) Decrease in expenses, due to erosion of the working capital items, loans and receivables (97) 29 127 Total transition from financial income to financial expenses from erosion of financial liabilities 845 206 (639) B. Other Financial Expenses Decrease in interest expenses (156) 2,700 2,856 Increased financial income – loans and receivables (17) (99) (82) Total decrease in other financial expenses: (173) 2,601 2,774 Total increase in financial expenses before capitalization 672 2,807 2,135 C. Capitalization to Projects under Construction Decreased capitalization of designated financing expenses consisting of: Capitalization of financing expenses and income due to erosion of designated loans - - - Decreased capitalization of interest expenses on designated loans (9) 33 42 Total decreased capitalization of designated financing expenses (9) 33 42 Increase in capitalization of undesignated financing expenses in the reporting period consisting of: Increased capitalization of financial expenses due to erosion of undesignated loans 23 37 14 Decrease in the capitalization of interest expenses on undesignated loans (10) 189 199 Increase in capitalization of undesignated financial expenses 13 226 213 Total increase in the capitalization of financial expenses, net 4 259 255 Total increase in financial expenses in the reporting period, compared to the same period in the previous year after the transfer to a regulatory asset and after capitalization of financial expenses 668 2,548 1,880 Presented in the Financial Statements Transfer of financial income to a regulatory asset 965 1,297 Finance expenses capitalization (259) (255) Other financial expenses 1,842 838 Total financial expenses 2,548 1,880



35


3. Condensed Quarterly Statements of Operations for 2009 are as follows

Adjusted to NIS of December 2009, NIS in millions 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total (Unaudited) (Audited) Revenues............... 5,234 4,359 5,331 3,870 18,704 Cost of operating the electricity system ..............................................

4,143

3,600

3,816

3,229

14,788

Profit from operating the electricity system.............................................

1,091

759

1,515

641

3,916

Sales and marketing expenses......... 203 162 184 200 749 Administrative and general expenses 232 261 205 208 816 Expenses (income) from liabilities to pensioners, net................................. (34) (123) (43) (15) (215) Income from current operations

690

459

1,169

248

2,566

Financial expenses, net ................... 870 351 637 532 2,390 Income (loss) from current operations before income tax .......

(180)

108

532

(284)

176

Expenses (income) from taxes on income............................................. (47) 28 (1,009) (34) (1,062) Income (loss) from current operations after taxes....................

(133)

80

1,541

(250)

1,238

The changes in operating results between quarters are due, inter alia, to: 1. a. Income - Changes in electricity rates during the reporting year – on May 7, 2009, the

electricity rate decreased by approximately 3.55%, mainly due to decreased fuel cost. On June 11, 2009, the electricity rate decreased by approximately 5.61%, due to decreased fuel prices. On December 13, 2009, the electricity rate decreased by approximately 4.00%, due to decreased fuel prices.

b. Seasonality affected by weather - during the winter and summer seasons the average electricity consumption is higher than that in the transitional seasons, and is often characterized by peak demand due to extreme cold or hot conditions. Electricity rates for consumers paying by load and time, which represent some 58% of consumed KWh, are higher on average in winter and summer than in the transitional seasons.

c. Expenses (income) from liabilities to pensioners, net – the main reason for the change is a provision arising from the announcement of the Supervisor of Wages and Work Agreements, in June 2009 regarding refunding amounts paid according to employees rights prior to the Supervisor's decision. For more details, see Note 19 (a)(2)(c) to the Financial Statements.

d. Taxes – the change in tax expenses derives from changes in future tax rates.



36

1. Business Position of the Corporation (continued) 4. Results of Operations by Segments for the Reporting Period

According to Section 33.b of the Government Companies Act and according to the provisions of circulars of the Government Companies Authority the Company was required, starting from the December 31, 2004 Financial Statements, to provide disclosure in the form of notes containing statements of operations and a balance sheet, with regard to the fields of activity included in the three segments of the electricity chain and detailing the premises and details used for their preparation (see Note 38 to the Financial Statements). The following are explanations concerning the results of operational segments: generation, transmission and distribution of electricity for the cumulative period, as presented in Note 38 to the Financial Statements: a. Revenues

Net revenues from the sale of electricity for the accumulated period derives from the sale of 48,947 million kWh, compared to the sale of 50,161 kWh in the same period the previous year, and is divided according to the following breakdown: 1. Generation - net revenues from the sale of electricity in the generation segment for

the cumulative period amounted to approximately NIS 14,180 million, compared to approximately NIS 19,592 million for the same period the previous year, an approximate NIS 5,412 million decrease in income. The decrease in revenues derives from two main factors: an approximate 1,214 million kWh consumption decrease at a rate of approximately 2.42%, which means a decrease of approximately NIS 477 million and a decrease of approximately NIS 4,935 million as a result of a real rate decrease.

2. Transmission - net revenues from the sale of electricity in the transmission segment for the cumulative period reached an amount of approximately NIS 1,686 million, compared to approximately NIS 1,711 million for the same period the previous year, an approximate NIS 25 million decrease in revenues deriving from a decrease in revenues as a result of a decrease in consumption, partly offset by the real increase in rates.

3. Distribution - net revenues from the sale of electricity in the distribution segment for the period reached an amount of approximately NIS 2,620 million, compared to NIS 2,697 million for the same period the previous year. An approximate NIS 77 million decrease in revenues for the distribution segment was derived mainly from decreased consumption, partly offset by a real increase in the rates of the distribution segment.

b. Depreciation and Amortization Expenses

1. Generation - depreciation and amortization expenses presented in the statement of operations for the generation segment for the cumulative period, amounted to approximately NIS 1,984 million, compared to NIS 1,912 million for the same period the previous year, an approximate NIS 72 million increase.

2. Transmission - depreciation and amortization expenses presented in the statement of operations for the transmission segment for the cumulative period, amounted to NIS 821 million, compared to NIS 818 million for the same period the previous year, an approximate NIS 3 million increase.

3. Distribution - depreciation and amortization expenses presented in the statement of operations for the distribution segment for the cumulative period, amounted to approximately NIS 1,091 million, compared to approximately NIS 1,054 million for the same period the previous year, an approximate NIS 37 million increase.



37


3. Results of Operations by Segments for the Report Period (continued) c. Fuel

Fuel consumption costs (without the salary component) for the generation segment in the cumulative period amounted to approximately NIS 8,674 million, compared to approximately NIS 12,825 million for the same period the previous year, an approximate NIS 4,151 million decrease derived mainly from a decrease in the amount of fuel consumed and also decreased fuel prices worldwide. Fuel consumption costs are attributed in their entirety to the generation segment.

d. Operating Costs 1. Generation - operating costs (without depreciation, fuel and expenses for liabilities to

pensioners, net) for the generation segment for the cumulative period amounted to approximately NIS 1,859 million, compared to approximately NIS 1,787 million for the same period the previous year, an approximate NIS 72 million increase.

2. Transmission - operating costs (without depreciation, fuel and expenses for liabilities to pensioners, net) for the transmission segment for the cumulative period amounted to approximately NIS 343 million, compared to approximately NIS 321 million for the same period the previous year, an approximate NIS 22 million increase.

3. Distribution - operating costs (without depreciation, fuel and expenses for liabilities to pensioners, net) for the distribution segment for the cumulative period amounted to approximately NIS 1,332 million, compared to approximately NIS 1,304 million for the same period the previous year, an approximate NIS 28 million increase.

e. Net Expenses from Liabilities to Pensioners Net income from liabilities to pensioners for the entire Company, amounted to approximately NIS 215 million for the reporting period. Distributing pension expenses between the various segments is done by the current salary ratio in operating costs for the electricity chain existing in the report period: 53.1% in generation, 7.1% in transmission and 39.8% in distribution.

f. Net Financial Expenses Net financial expenses are divided between the various segments mainly according to the net ratio of active fixed assets. Financial expenses after capitalization, for the entire Company, amounts to approximately NIS 2,390 million for the reporting period compared to financial expenses of approximately NIS 2,548 million for the previous year, an approximate NIS 158 million decrease in net finance expenses. In the generation segment: an approximate NIS 78 million decrease. In the transmission segment: an approximate NIS 38 million decrease and in the distribution segment: an approximate NIS 42 million decrease.

5. Operating Results by Reporting Units for the Report Period According to Section 33.b of the Government Companies Act and according to the provisions of circulars of the Government Companies Authority the Company was required, starting from the December 31, 2004 financial statements, to provide disclosure in the form of notes containing statements of operations and a balance sheet, with regard to the fields of activity included in the three segments of the electricity chain and detailing the premises and details used for their preparation (see Note 38 to the Financial Statements). Upon analysis of the results of the activities of the various units and regarding rates set by the Electricity Authority for the segments, one might recognize that the generation segments attained the required returns. The transmission segment and the distribution segment attained a negative return because of a lack of rate coverage for all normative costs, deriving mainly from the continuation of high efficiency accumulation in the rate.



38

1. Business Position of the Corporation (continued) G. Liquidity for the Reporting Period

The cash surplus created from current activities, from taking long term loans, from other loans and from raising capital by issuing debentures, was used largely to finance development activity required by the electricity sector, meaning investment in fixed assets amounting to approximately NIS 3,872 million and repayment of loans amounting to approximately NIS 5,734 million. The Company presented a cash surplus in the reporting period deriving from current activities in the approximate amount of NIS 6,691 million, compared to approximately NIS 2,345 million for the same period the previous year, an approximate NIS 4,346 million increase. The amount of cash used for investment activities in the year 2009 reached approximately NIS 3,809 million compared to NIS 2,788 million as of December 31, 2008, an increase of NIS 1,021 million. The amount of cash used for financing activities in 2009 amounted to approximately NIS 2,667 million, compared to approximately NIS 3,621 million and derived in the same period last year, a change of NIS 6,288 million.

2. Details Concerning Exposure to Market Risks and their Management

a. The Company's Market Risk Manager

The Company's person responsible for market risk management is the Senior Vice-President of Finance and Economics, Mr. Harel Zeev Blinde. The following are his details:

a. Entered Service: April 2008 b. I.D. no.: 024300634 c. Year of Birth: 1969 d. Citizenship: Israeli e. Corporate Position: Senior Vice-President of Finance and Economics. f. Position in Corporate Subsidiary or Interested Party: None. g. He is not a family member of any other Company executive or interested party. h. Education: B.A. in Economics and Mathematics. i. Business Experience for the Past 6 Years: Vice President of Finance and Economics

at the Company, in the years prior to the current position, served in different roles in the Ministry of Finance: Vice Commissioner of Budgets, Deputy Commissioner of Budgets and Head of Security field at the Budget Department in the Ministry of Finance.

b. The Financial Crisis

The forceful outbreak of the current global financial crisis in September 2008, upon the

collapse of Lehmann Brothers Investments Bank created more severe conditions than in the past for raising funds in Israel and abroad. Moreover, there was a reduction in the supply of sources of bank financing due to stricter terms for obtaining credit from banks.

Current indicators in the last six months of 2009 show: (1) a change in trend and a return to positive growth in Israel's economy. (2) the Israeli economy will probably continue to grow at a higher growth rate than the majority of the developed economies. Nevertheless, a concern still exists that the growth rate will continue to be slow, mainly due to the fact that the recession is not over as yet in the U.S.A. and several European countries.

Experts estimate that decline of the global crisis has slowed and that the recovering capital markets show more liquidity, although volatile and sensitive to changes, in light of the economic recession expected for 2010 as well, in the U.S.A. and the Euro bloc. This recession will require governments to take additional steps to accelerate economic activity.



39

2. Details Concerning Exposure to Market Risks and their Management (continued) b. The Financial Crisis (continued)

a. Capital raising -

1. Capital raising in Israel -Experts estimate that the Israeli Government will have to raise capital in small amounts in the next few months since 2009 ended with a smaller than planned deficit of about NIS 5 billion and a smaller than expected deficit for 2010 as well. Despite reduced banking credit sources, recovery in credit availability and the Company's funds raising ability from the banking and non-banking systems in Israel and abroad is expected in light of the curbed slow-down in the Israeli economy and the expectation of a low volume of funds raised by the government in 2010.

2. Capital raising abroad – Pursuant to steps taken by central banks and governments throughout the world to alleviate the credit crisis and introduce positive momentum, recovery in the global capital markets and, as a result of that, the Company's capital raising ability in international capital markets has become apparent. Nevertheless, many banks in the U.S.A. are still refraining from granting the credit required by companies and according to experts estimates, the credit volume of the American economy is even decreasing.

c. Description of the Company’s Market Risks

The Israel Electric Corporation Ltd. sells its product, electricity, at a price set by an outside body - the Electricity Authority. The price is based on the cost principle. Notwithstanding the setting of the recognized costs, the Electricity Authority fixed the normative costs of the different components in the rate, which occasionally do not match the Company’s actual costs. As a result, regarding the bulk of its activities, the Company is not exposed to market risks, with the exception of the following: (a) Financing

1. Exchange Rate Differentials In order to finance its investments in fixed assets, the Company elicited loans, the net balance of which (after debenture discount/premium, current maturities, issuing expenses and hedge transactions and less liability reserve fund and employee bonuses) amounts to approximately NIS 42,296 million as of December 31, 2009 (approximately NIS 21,878 million in Israeli currency and some NIS 20,418 million in foreign currency). To finance the Company’s 2010-2014 development plan, the Company will require significant additional external financing sources. As set by the rate structure, two thirds of the Company’s active assets, recognized by the Electricity Authority, shall be financed by external capital, of which 47.43% (as of December 31, 2009) shall be in foreign currency, according to the makeup of the Bank of Israel’s basket of currencies; the Company has rate coverage with respect to this structure and makeup, (see Note 17 (5)b to the Interim Financial Statements). For the balance of foreign currency loans, the Company is exposed as follows: a. Actual liability level exposure is approximately 56.0% (approximately 43.2%

after hedge transactions) compared to the liabilities level recognized in the rate. b. Exposure to differences between the weights of the foreign currencies to which

the Company’s loans are linked compared to the weight of the currencies according to the makeup of the Bank of Israel’s basket.

2. Interest on All of the Company’s Loans The Company is exposed to the difference between the interest rate recognized (in foreign currency and NIS), in the basis of the rates which only change upon the yearly rate update, and the actual interest rate (in foreign currency and NIS) with respect to its loans.



40

2. Details Concerning Exposure to Market Risks and their Management (continued) c. Description of the Company’s Market Risks (continued)

3. Exposure to Real Exchange Rate Differences IAS 23 states that in capitalization of borrowing costs the full principal and interest

differences related to loans in foreign currency should be capitalized, as long as these costs do not exceed the cost of alternative financing cost in local currency and at least the amount of interest expenses in foreign currency for the period. Consequently, the Company is exposed in its Financial Statements to real devaluations/ revaluations arising from some of the loans in foreign currency that finance assets under construction. See also Note 2(b) to the Interim Financial Statements as of December 31, 2009 for additional details.

(b) Input Price Change The input basket for the other rate components (except for fuel costs) was linked to changes in the CPI. Therefore, the Company is exposed to market risks deriving from a real increase in the prices of other inputs.

(c) Capital Market Changes Affecting the Pension Funds and Pension Liability The Company is obliged to maintain an appropriate financial fund in the central pension fund to Company employees ("The Fund"), that will enable pension payments to entitled employees, according to the actuarial liability, calculated by the actuary of the Fund. The main risks to which the Company is exposed are: Average duration risks – the changes in yields of Government debentures have the highest effect on the financial value of the liabilities (the reserve) compared to the financial value of the assets (the fund) caused by the longer average duration of the reserve compared to that of the fund. The investments policy of the Fund and its effect of the fund – The fund held by the Fund includes various assets, comprised mostly of Government debentures and NIS linked bank deposits. Therefore, the yield of the fund is affected by the fundamental risks of markets behavior and its effect on the composition and value of the assets in the fund. Reduction of market risks requires therefore, distribution of investments in terms of the held financial assets mix, the average duration, credit rating, etc. Credit risks – failure of a third party to meet its obligations to the Fund may decrease the value of Fund assets.

d. The Company’s Policy for Managing Market Risks

a. The Company’s policy for Managing Market Risks of Exposure to Foreign Currency The policy of the Company is to designate management of market risks arising from exposure to foreign currency to the economic exposure of the Company. So as to minimize the Company’s exposure to foreign currency fluctuations, the Investments and Risks Management Committee has reached the following decisions concerning the Company’s exposure: 1. The sum of real exposure due to liabilities linked and denominated in foreign currency

passed on to electricity consumers- the Company will execute foreign currency hedge transactions (mainly swap and forward) to conform the expense structure to the recognized revenue structure (the makeup of the Bank of Israel’s basket of currencies). The swap transactions will be for a minimum of two years taking into account the differences in interest rates between the various currencies with a permitted possible exposure of up to 15% of the balance of loans in the currency in question.

2. Concerning the balance of exposure of the Company's foreign currency liabilities (after implementing paragraph 1 above) - the Company shall replace foreign currency liabilities with index linked liabilities by entering into foreign currency-index hedge transactions (mainly forward and swap), and if market conditions justify it, foreign currency-NIS transactions so as to minimize exposure to foreign currency.



41

2. Details Concerning Exposure to Market Risks and their Management (continued) c. Description of the Company’s Market Risks (continued)

Swap transactions shall be for a minimum of two years taking into account inflation in Israel and Western countries, along with capital market interest rates. As a rule, transactions shall be executed in order to cover at least 85% of the balance of exposure, so that the amount exposed in each currency will not surpass the cumulative value of 15% of the loan balance in the currency in question.

3. So as to permit the dynamic implementation of the policies, as stated in paragraph 2 above, and so as to avoid technical random deviations, the Deputy CEO for Finance and Economics has instructed that the amount exposed in each currency, both for the hedged sum and for the balance of the exposure shall be no greater or smaller than 5% of the loan balance for the currency in question, with the addition of 2% of the loan balance for each 1% of the interest gap if it is negative to the Company's detriment.

4. Deviation beyond 15% will be permitted if the amount of the deviation is no greater than $10 million or the equivalent of that sum in any other foreign currency, each foreign currency separately.

5. Other transactions such as options, IRS in currencies and interest rates shall be carried out if market conditions indicate feasibility/ risk minimization.

2. Details Concerning Exposure to Market Risks and their Management (continued)

d. The Company’s Policy for Managing Market Risks

b. Steps taken by the Company to Contend with Market Risk Affecting Pension Funds and Pension Liabilities The Company acts to supervise and control, as far as possible, the ability of the Fund to effect payments to entitled employees out of its assets, as follows: 1) The Company has two representatives, a management representative and an employees

representative, in the Fund's Board of Directors and in its committees. These directors participate in defining the suitable policy for managing the funds, including providing a solution to the risk of average duration gaps between the assets and the liabilities by adjusting, as best as possible, the average duration of the assets to investments, with due consideration of the borrower's risks and investment volume and also investing the major share of Fund assets in NIS linked assets.

2) Aiming to reduce the fluctuations in transfers to the Fund, mainly due to the change in the yields curve for capitalizing the actuarial liability, the Company is currently in an advanced process jointly with the Fund, to amend the Articles of the Fund, for the purpose of spreading the "deviating debt" to the Fund over 10 years instead of the current requirement of one year.

c. Division of Responsibility and the Scope of Authority in the Company’s Management, in

Managing the Exposure to Foreign Currency As per the Company’s policy concerning the treatment of exposure deriving from market risks, as detailed above, the head of the Finance Department is authorized to approve transactions, with the exception of currency exchange transactions and additional transactions which require the approval of the Deputy CEO for Finance and Economics as detailed in section 4 a 5 above. In addition, the Board of Directors has determined that certain Company employees shall perform, on behalf of the Company, hedge transactions in accordance with its policy. A detailed report shall be delivered to the Board of Directors each quarter, as part of the deliberation of the Financial Statements, concerning the currency exposure at the end of each quarter and the hedge transactions carried out over the current quarter.



42

2. Details Concerning Exposure to Market Risks and their Management (continued) e. Supervising and Realizing the Risk Management Policy

a. Actual Treatment by the Board of Directors As mentioned above, the Board of Directors receives a quarterly report on the subject of the Company’s risk management and exposure to market risks.

b. Company Control Mechanisms The Company's Internal Audit occasionally tracks the performance of decisions made by the Board of Directors and its committees on the subject of exposure to foreign curency.

c. Losses/Contracts Deriving From Market Risks due to Exposure to Foreign Currency

Over the course of the reporting period the Company incurred a loss of approximately NIS 372 million as a result of currency exchange transactions. In addition, the Company derived a gain from forward transactions amounting to approximately NIS 138 million. The purpose of hedge transactions is to hedge the Company’s exposure to foreign currency and their results are the reverse of the results of the exposure of the base asset - the Company’s foreign currency liabilities. Therefore, one must note that the aforementioned NIS 234 million loss was offset in part by an identical income deriving from loan erosion, on account of which these forward and swap transactions were made.

f. Further Details Concerning the Management of Financial Market Risks According to a Circular of the Government Companies Authority According to the January 2005 Government Companies Authority circular, the following details are required from Government companies: a. The Company maintains a periodic system for the management of financial market risks,

by carrying out monthly tracking of its financial liabilities and their hedges. b. The Company has tracked its liabilities over the reporting period and has performed

hedges based upon its needs and according to set policy, after consultation and independent opinions from outside experts.

c. The chances of loss from the various investments, and the Company’s debts as a result of the possibility that the opposing party in the transaction or the Company’s debts will fail to meet their obligations or in the absence of the possibility to legally enforce the existence of a debt, are equal to the balance of these assets in the Company’s balance sheets.

d. The Company has no market risk from off balance sheet positions, as the purpose of these transactions is purely defensive.

As a rule, the Company acts in the matter of finances and investments according to law so as to minimize costs and achieve maximum returns, while spreading its investments throughout various banks. This activity, like all Company activities, is examined by the Company’s Internal Audit following accepted auditing standards and according to a work plan approved by the Audit Committee of the Board of Directors.

g. Linkage Basis Report Regarding information concerning the linkage terms of the Company's monetary balances as of December 31, 2009, and the same period in the previous year, see the table in Note 27 to the Financial Statements.

h. Sensitivity Tests See Note 27 to the Financial Statements for information on sensitivity tests.

i. Derivative Positions According to Company policy detailed in paragraphs 4 above, the Company has engaged in currency exchange transactions constituting hedging transactions, the balances of which as of December 31, 2009 is a follows:



43

2. Details Concerning Exposure to Market Risks and their Management (continued)

f. Further Details Concerning the Management of Financial Market Risks According to a Circular of the Government Companies Authority (continued)

- The purchase of $305 million in consideration of €290.5 million for a period of 7 years.

The net fair value as of December 31, 2009 is an approximately NIS 457 million obligation.

- The purchase of $240 million in consideration of £165 million for a period of 5 years. The net fair value as of December 31, 2008 is an approximately NIS 97 million asset.

- The purchase of $900 million in consideration of NIS 3,295 million for a period of up to 10 years. The net fair value as of December 31, 2009 is an approximately NIS 45 million obligation.

- The purchase of € 90 million in return for NIS 418 million for a period of up to 2 years. The net fair value as of December 31, 2009 is an approximately NIS 1 million asset.

- The purchase of £62 million in consideration of NIS 288 million for a period of up to 2 years. The net fair value as of December 31, 2009 is an approximately NIS 65 million obligation.

- The purchase of ¥ 54,000 million in consideration of NIS 2,282 million for a period of up to 2 years. The net fair value as of December 31, 2009 is an approximately NIS 161 million obligation.

- The purchase of € 47 million in consideration of $ 60 million for a period of 7 years. The net fair value as of December 31, 2009 is an approximately NIS 21 million asset.

- The purchase of $400 million in consideration of NIS 1,852.4 million for a period of 25 years. The net fair value as of December 31, 2009 is an approximately NIS 145 million obligation.

In addition, the Company makes use of forward transactions the balances of which as of December 31, 2009 is as follows:

- The purchase of $ 95 million in consideration of NIS 358 million for a period of up to one year. The net fair value as of December 31, 2009 is an approximately NIS 2 million obligation.

- The purchase of NIS 206 million in consideration of $ 54 million for a period of up to one year. The net fair value as of December 31, 2009 is an approximately NIS 47 million obligation.

- The purchase of NIS 683 million in consideration of € 125 million for a period of up to one year. The net fair value as of December 31, 2009 is an approximately NIS 3 million obligation. These financial instrument transactions are carried out with banking institutions and in the Company’s opinion, no losses deriving from credit risks are expected as a result. The balance of transactions as of the date of the balance sheet is the highest balance. The Company does not hold or sell financial instruments for trading.

3. Aspects of Corporate Governance a. Contributions

The Company is prevented from making contributions in light of Government Companies Authority directives. At the same time, the Board of Directors of the Company approved on September 16, 2009, the transfer of two voltage transformers and two current transformers, disassembled from the Old Yavneh power station, which the Company could not use any longer as such, to the University Center at Ariel, as part of the business relations between the Company and the University Center, that trains engineers and technicians who are Company employees as power current engineers.



44

3. Aspects of Corporate Governance (continued) b. Directors Possessing Accounting and Financial Skills

In accordance with the Securities Regulations (Periodic and Immediate Statements) - 1970, concerning the reporting on Directors with financial and accounting skills, the Board of Directors has decided that the appropriate minimal number of Directors possessing accounting and financial skills is three, this taking into account, among other things, the size of the Company, its type and character, the complexity of its activities and the number of members of the Board of Directors. In the opinion of the Board of Directors, this number will permit the Board of Directors to meet the obligations imposed upon it in the framework of the new directive, including obligations imposed upon it under law and the Company’s documents of incorporation, especially as it pertains to its responsibility in examining the Company’s financial condition and in issuing and approving Financial Statements. These Directors have been integrated into committees of the Board of Directors dealing with financial and accounting matters, as follows: Planning and budgeting, finance, balance sheets and offerings, primary tender committee, auditing, properties and construction, organization, manpower and procedures, regulation, marketing communications and customer relations, investments and risk management. For this report, the Company has four Directors possessing accounting and financial skills. The following are their details, denoting the facts from which their Directorships derive, and detailing the committees of the Board of Directors of which they are members:

Mr. Mordechai Friedman (Chairman of the Board) - CPA, B.A. in Economics and Accounting from Tel Aviv University and an accountant since 1979. Served as managing partner at the Deloitte Brightman Almagor consulting group and since 2005 has served as Deputy Chairman and Chief Business Manager for this group. Former and present public positions: plenum member of the Israel Securities Authority (1983-1995), Chairman of the Building Committee of the Institute of Certified Public Accountants in Israel and member of various ICPA committees (starting 1992), former member of the Tribunal for Business Restrictions, was a permanent observer at the Israeli Accounting Standards Board during the years 1997- 2008. A member of all Boards of Directors committees except the Audit Committee. On February 20, 2010, Mr. Mordechai Friedman ended his term of service in this position.

Mr. Michael Lazer - CPA, graduate of the Hebrew University (Tel Aviv Extension) in Accounting. Partner at Strauss, Lazer & Co. auditing firm. Mr. Lazer has been working in the field of accounting since 1972, mainly in the field of taxation, and has provided consulting to corporations in Israel and abroad. Member of the following Board of Directors committees: Chairman of the Finance, Balance Sheet and Offerings Committee, Actuarial Liabilities Study Committee, Premier Tender Committee, Properties and Construction Committee, the Organization, Manpower and Procedures Committee, Audit Committee and Strategy Committee.

Ms. Shulamit Eshbol - a lawyer and a CPA. Partner in the Eshbol Yakuel law firm. B.A. in Accounting from the College of Management and L.L.B in Law from the Herzliya Interdisciplinary Center. Serves as the Chairperson of the Audit Committee at Haifa University for the last three years. Member in the following committees of the Board of Directors: Chairperson of the Environment Committee, Chairperson of the Corporate Government and Ethical Code Committee, Chairperson of the committee to review the actuarial liability, member of the Strategy Committee, the Assets and Construction Committee, the Marketing Communication Committee and the Finance, Balance Sheet and Issue Committee.



45

3. Aspects of Corporate Governance (continued) b. Directors Possessing Accounting and Financial Skills (continued)

Dr. Ziv Reich, an external Director, CPA, B.A. in Business Management specializing in Accountancy from the College of Management, Tel Aviv, MBA in Administration and Internal Auditing, Bar Ilan University and Ph.D. in Business Management, Warnborough University, London and Dean of the Insurance School in Netanya Academic College. Academic lecturer on accountancy, taxation and finance. Author of numerous books on accountancy and taxation. Deputy Chairman of the Advisory Committee for Supervision of Financial Institutions in the Ministry of Finance. Chairman of the National Training and Advanced Studies Committee of the Institute of Internal Auditors and CEO of The Ramle Foundation for Education, Culture and Development. Member of the following committees of the Board of Directors: Supreme Tenders Committee; Audit Committee; Finance, Balance Sheet and Issue Committee and the Assets and Building Committee.

c. Independent Directors

Amendment No. 8 of the Companies Law, defines arrangements aimed at reinforcing the independence of the Board of Directors of a public company, and states, inter alia, that a public company is entitled to include in its Articles a stipulation, whereby independent Directors, in the number defined by the company will serve in its Board of Directors and the company is also entitled to set their percentage out of the serving members of the Board of Directors. The regulation recommends appointing a majority of independent Directors, and in a company with a control holder or a control holder of a concern, one third of independent Directors is sufficient. Since the authority to appoint Directors is granted to the Minister of Finance and the Minister of National Infrastructures in consultation with the appointments review committee, the Company addressed on February 8, 2009 the Government Companies Authority and requested to receive its position and guidelines on adopting the independent Director's arrangement, their number and service period.

The position of the Government Companies Authority as received by the Company on February 24, 2009, is that including a binding stipulation in the articles of a government public company that requires the appointment of a certain number of independent Directors, as defined in Amendment No. 8 to the Companies Law may impose significant limitations on appointing Directors for that company, due to the strict requirements which an independent Director has to fulfill in his relations with the State and entities under its control. On the other hand, it does not seem that such a binding stipulation will contribute to significantly improve the activity of the Board of Directors in the Company and reinforce its independent status, above the current defenses provided by the stipulations of the Government Companies Law and the principles of the administrative law.

d. The Company’s Internal Auditor

1. Details of the Internal Auditor a. The Internal Auditor is Mr. Shay Rosenstock, who began his service as the Internal

Auditor on August 2, 2009. b. The Internal Auditor conforms to the conditions stipulated in section 146(b) of the

Companies Law - 1999 ("Companies Law") and to the directives of section 8 of the Internal Audit Law - 1992 ("Internal Audit law").

c. The Internal Auditor is an employee of the Company and does not act in any other capacity in the Company, in addition to the Internal Audit, except for the position of the ombudsman for public and employees' complaints. Fulfilling these additional roles does not affect his ability to perform his primary role.

d. .The Internal Auditor does not have any material business relations or other material relations with the Company and does not hold any position outside the Company which create, or may create, a conflict of interests with his role as an Internal Auditor.



46

3. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued)

2. Appointment Process On April 23, 2009 the Audit Committee recommended to the Board of Directors that

Mr. Shay Rosenstock should be chosen for the position of an internal auditor of the Company, as according to recommendations received and in light of the added value he brings, of a different view of the system, the managing experience, professional knowledge and his personality. This recommendation of the Audit Committee was submitted to meeting No. 1273 of the Board of Directors on April 23, 2009, where it was decided that: "the Board of Directors chooses Mr. Shay Rosenstock, as the Internal Auditor of the Company and Mr. Yigal Harel as the qualified substitute. The appointment of the Internal Auditor is for a trial year. The permanent appointment will be submitted to the approval of the Board of Directors at the end of the trial year".

3. Identity of the Supervisor of the Internal Auditor a. The CEO and the Chairman of the Board of Directors of the Company supervise the

Internal Auditor and Public Complaints Commissioner on behalf of the organization. b. The identity of the supervisors conforms to section 49 of the Government Companies

Law.

4. Work Plan a. Work plans of the Internal Audit include a multi-year schedule (five years) and an

annual work plan. The annual work plan is based on results of a risk analysis - structure and process for

five years (2008 - 2012), approved by the Audit Committee of the Board of Directors in December 2007. An update of the risk analysis was approved by the Audit Committee of the Board of Directors in December 2008. The work plan includes, as far as is known in advance, audit tasks required by the Board of Directors and the CEO and tasks recommended by Division and Department Managers, approved by the Internal Auditor. The annual work plan for the Internal Audit for 2009 was approved by the Audit Committee of the Board of Directors on December 11, 2008 and by the Board of Directors on January 8, 2009.

In August 2009 the Internal Audit started a general processes risks review. The risks review will serve as the basis for outlining a new multi-year work plan for the Internal Audit for the years 2010 - 2013. The multi-year work plan (2010-2013) and the work plan for 2010 are scheduled to be submitted to the approval of the Audit Committee in May 2010. Up to the date of plans approval by the Audit Committee and the Board of Directors, the Internal Audit will act according to a temporary work plan. The temporary work plan of the Internal Audit for 2010 was approved by the Audit Committee of the Board of Directors in December 17, 2009 and by the Board of Directors on December 24, 2009. The plan is based on the results of the aforementioned risks review.

b The Internal Auditor submits a proposed annual work plan, in coordination with the Chairman of the Board of Directors and the CEO. The annual work plan is discussed and approved by the Audit Committee and by the Board of Directors.

c. Demands to perform audit tasks and audits with higher priority than other tasks during the work year, are initiated by the Chairman of the Board of Directors, the Chairman of the Audit Committee, the CEO, members of the Board of Directors and the Internal Auditor. In addition, the Internal Audit conducts audits that are not planned in advance during the year, pursuant to audit reports of the State Comptroller and pursuant to direct and anonymous complaints received at the Company. All these create changes in the work plan during actual implementation. The priorities for performing audit tasks during the work year were approved by the Audit Committee in January 2008, according to a defined priority scale.



47

. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued)

The annual work plan of the Internal Audit for 2009 includes allocation of work days to

perform unscheduled tasks at the rate of 40% of the scheduled work days designated for the audit. The annual work plan of the Internal Audit for 2010 includes allocation of work days to perform unplanned tasks at a rate of 45% of the scheduled work days designated for the audit. The Internal Auditor submits a semi-annual report every year, summarizing the Internal Audit reports completed during January – June of the same year. The semi-annual report includes a list of tasks scheduled for the current year which were not performed during the current year and will not be performed in the subsequent year. The Internal Auditor prepares an annual report every year, summarizing the Internal Audit reports completed during that year. The semi-annual report and the annual report of the Internal Audit are submitted to the Chairman of the Board of Directors, the Chairman of the Audit Committee of the Board of Directors and the CEO

d. The Internal Auditor submitted in 2009 an audit report on the subject of transactions that require special approvals – exceptional transactions with stakeholders that took place up to March 2009. The material transactions in 2009 were not yet audited by the Internal Auditor and are scheduled to be audited during 2010.

e. The Internal Audit submitted 8 audit reports in the area of computerized information systems during the reporting period, January - December, 2009.

5. Audit of Held Companies a. Work plans of the Internal Audit include, from time to time, audit of the Nichsay

Ha'yarden Ltd., subsidiary. b. An Internal Auditor was appointed for the National Coal Supply Corporation.

6. Scope of Employment a. The Internal Audit has 43 budgeted positions for employees who perform audits and

handle public and employees complaints (including administrative and secretarial employees). The Internal Auditor clarifies complaints from the public, including employee complaints, assisted by employees of the Internal Audit.

b. The work scope of the Internal Audit enables audits of material issues in the Company about once every five years.

7. Performance of the Audit

a. As stated by the Internal Auditor, audits are conducted according to accepted professional standards of Internal Auditing, in accordance with the applicable laws and in conformance to the Internal Audit Law – 1992 and to the directives of the Government Companies Authority, furnished from time to time in circulars of the Government Companies Authority.

b. The Board of Directors and the Audit Committee assess that the Internal Auditor conformed to the requirements specified in the professional standards.

8. Access to Information The Internal Auditor and his representatives are granted free, continuous and direct access to every hard copy or digital document, data, database, or information, including financial data, for performing their tasks. The Internal Auditor and his representatives are entitled to enter every asset and inspect it, in conformance with the contents of section 9 of the Internal Audit Law.

9. Reports of the Internal Auditor a. Reports of the Internal Auditor are submitted in writing. The Internal Auditor submits a

summarized report of the work of the Internal Audit and a follow-up report on implementation of decisions and recommendations.



48

3. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued)

b. During the work year, the Internal Auditor submits final versions of audit reports to the

Chairman of the Board of Directors, to the CEO and to the Chairman of the Audit Committee of the Board of Directors. Audit reports are submitted to the members of the Board of Directors, to members of Management and to the audited entities through the Secretary of the Board of Directors. The semi-annual reports submitted by the Chairman of the Board of Directors to the Finance and Infrastructures Ministers and to the Manager of the Companies Authority include a report on the performance of the Internal Audit in the Company.

c. During January - December, 2009, the Internal Auditor presented 99 reports: 73 audit reports and 26 examination reports. During this period, the Audit Committee of the Board of Directors held 11 discussions on the Internal Auditor’s findings and recommendations which took place on January 15, 2009, March 12, 2009, April 23, 2009, May 21, 2009, June 18, 2009, July 16, 2009, August 13, 2009, October 15, 2009, October 22, 2009, November 19, 2009 and December 17, 2009. In addition, the Internal Auditor conducted an embezzlement and fraud risks review during the report year. The review was discussed by the Audit Committee in June 2009.

10. Evaluation of the Board of Directors of the Internal Auditor’s Activities

The scope of the Internal Auditor’s activities allows the auditing of material subjects once every 5 years or so. This scope, the character and continuity of the Internal Auditor’s activities and his work plans are, in the Board of Director’s estimate, reasonable and are capable of realizing the Company’s Internal Auditing goals.

11. Wages The Internal Auditor is an employee of the Company, employed on an individual contract. The Board of Directors estimates that the wages do not affect the ability of the Internal Auditor to exercise his professional consideration.



3. Aspects of Corporate Governance (continued) e. Fees of the Outside Auditor Pursuant to section 36a(b) of the Securities Law - 1968, the total fees to which the outside auditor

was entitled in respect with audit services and other services relating to the years 2008 - 2009 are detailed below:

For the year ended on December 31 2009 2008 Brightman

Almagor Zohar& Co. firm

Brightman Almagor Zohar & Co. firm

Hours NIS'000 Hours NIS'000 a. Fees for audit services,

for services related to audits and for tax services

11,500

1,740

11,550

1,744 b. Other fees - total fees

for services provided by the outside auditor which are not included in paragraph (a) above

14,100

2,600

10,424

2,974

Details of types of services included in the amounts in paragraph (b): 1. Accompanying the company in its preparations for implementing Government Company

Regulations on the subject of the testing of effectiveness of the internal controls on financial reporting.

2. Performance of special examinations in accordance with directives of the Government Companies Authority.

3. Preparation of opinions, in accordance with the requirements of State authorities and/or on accounting and other subjects.

4. Accompanying the company in internal discussions with external parties. 5. Issuing various certifications. * In addition, an amount of approximately NIS 707 thousand was paid to Kost Forer Gabai & Kasirer

firm for services related to capital rising abroad (the firm terminated its role as auditors in 2007).



50

3. Aspects of Corporate Governance (continued) f. Financial Report Approval Process

In accordance with Securities Authority directives dated July 23, 2007 concerning financial report approval procedures for a reporting corporation (according to Section 36a(b) of the Securities Act 1968), the Company must provide information concerning the financial statement process and supervision, as follows:

1. The Nature of the Organs Responsible for the Approval Process of the Financial Statements The Company’s Board of Directors headed by the Acting Chairman of the Board, Mr. Michael Lazer, who acts as the chairman of the Board’s Finance, Balance Sheet and Offerings Committee, Dr. Ziv Reich as well as CEO Mr. Amos Lasker and Senior VP of Finance and Economics, Harel Zeev Blinde.

The following are the dates of meetings with respect to overall control, including the names and positions of participants:

Meeting of the Finance, Balance Sheet and Offering Committee dated March 18, 2010: Mr. Amos Lasker Chief Executive Officer Mr. Harel Blinde Senior Vice President, Finance and Economics Mr. Michael Lazer Chairman, Finance, Balance Sheet and Offerings Committee Mr. David Yahav Legal Advisor and Company Secretary Ms. Dorit Inbar Board Member Ms. Shulamit Eshbol Board Member Mr. Amit Oberkovich Board Member Mr. David Golan Company Spokesman Mr. Philip Mandelker Board Member Ms. Blanche Kay Board Member Mr. Ziv Reich Board Member Mr. Shay Rosenstock Internal Auditor Mr. Moshe Bachar Deputy CEO and Senior Vice President, Generation &

Transmission Ms. Rochell Don-Yichia Board Member Mr. Gideon Frank Board Member

Meeting of the Finance, Balance Sheet and Offering Committee dated March 28, 2010: Mr. Amos Lasker Chief Executive Officer Mr. Harel Blinde Senior Vice President, Finance and Economics Mr. Michael Lazer Chairman, Finance, Balance Sheet and Offerings Committee Mr. David Yahav Legal Advisor and Company Secretary Ms. Dorit Inbar Board Member Ms. Shulamit Eshbol Board Member Mr. Philip Mandelker Board Member Ms. Blanche Kay Board Member Mr. Ziv Reich Board Member Ms. Rochell Don-Yichia Board Member Mr. Avraham Natan Board Member Mr. Shimon Eckhaus Board Member



51

3. Aspects of Corporate Governance (continued) f. Financial Report Approval Process (continued)

1. The Nature of the Organs Responsible for the Approval Process of the Financial Statements (continued)

Meeting of the Board of Directors on March 28, 2010: Mr. Amos Lasker Chief Executive Officer Mr. Harel Blinde Senior Vice President, Finance and Economics Mr. Michael Lazer Chairman, Finance, Balance Sheet and Offerings Committee Mr. David Yahav Legal Advisor and Company Secretary Dr. Ziv Reich Board Member Mr. Izhak Elyashive Board Member Mr. Avraham Natan Board Member Mr. Shimon Eckhaus Board Member Ms. Blanche Kay Board Member Ms. Rochelle Don-Yechiya Board Member Mr. Philip Mandelker Board Member

2. Steps Taken by Persons Entrusted with Overall Control in the Company

The Company acts in accordance with the directives of the Government Companies Authority published in the Regulations [Additional Report Concerning Actions Taken and Representations made to Ensure Correctness of the Financial Statements and the Directors’ Report-2005 (hereby: “the Regulations”)], according to which Government companies, the Company among them, must attach to their Financial Statements, both yearly and quarterly, an additional report in which Company officers responsible for setting and enforcing controls and procedures in the Company declare, for the purpose of the disclosure required for the reports, that controls and procedures in question have been set, in order to ensure the correctness of the Financial Statements and the Directors’ Report. After the completion of the Financial Statements and their approval by the Senior Vice President, Finance and Economics and CEO of the Company, the reports are transferred to the office of the Board of Directors. The Financial Statements are brought before the Finance Committee and the plenum of the Board of Directors for discussion and approval (as part of the discussions of the Finance, Balance Sheet and Offerings Committee and the plenum of the Board of Directors, the salient points of data, findings and conclusions in the report drafts are presented and noted). The external auditor of the Company and its legal advisor also participate in the meeting. After the aforesaid discussion and answers to questions and comments from members of the Board of Directors that are prepared in advance and/or may arise during the meeting of the Board of Directors, the Financial Statements are approved in a voting process.



52

3. Aspects of Corporate Governance (continued) F. Financial Report Approval Process – Supervision (continued)

2. Steps Taken by Persons Entrusted with Overall Control in the Company (continued)

The Company has formulated a “Workings of the Disclosure Committee on the Subject of Disclosure in the Financial Statements” procedure, which includes the formation of a Disclosure Committee for the purpose of, among other things, confirmation, implementation and execution of examinations of control effectiveness over the periodic Financial Statements, including verification that the information contained in the reports is complete, accurate and proper, as well as for confirming controls and procedures ensuring the disclosure of the aforementioned information and the assessment and reporting of their effectiveness, discussion of inherent weaknesses that require disclosure, reporting and tracking of the correction of these weaknesses, etc. The findings and recommendations of the committee are reported to the Senior Vice President - Finance and Economics. In addition, the Company has set a “Working Procedure for the Approval of Financial Statements, Changes in Critical Accounting Policies and Changes in Actuary Premises” (hereby: “the Procedure”) which sets in place, among other things, a discovery, treatment and reporting mechanism concerning events and information that may influence critical accounting policies and/or actuarial assumptions according to which the Company operates, including transferring reports and discussions to the appropriate Company persons, comprising the Senior Vice President - Finance and Economics, the Senior Vice President - Strategic Resources, the CEO, the Chairman of the Finance Committee of the Board of Directors, members of the Finance Committee of the Board of Directors, the Chairman or Acting Chairman of the Board of Directors and members of the Board of Directors.



53

4. Instructions for Disclosure Related to the Financial Reporting of the Corporation A. Events that occurred after the financial report date See details in Note 36 to the Financial Statements. B. Critical Accounting Estimates

Sensitivity analyses of the change according to key factors and estimate as at December 31, 2009 are presented below:

Actuarial Assumption Change Increase Change Decrease Interest rates for capitalization (0.1%) 228 0.1% 242 Wage increase rate 0.5% 429 (0.5%) 396 Pension increase rate 0.5% 647 (0.5%) 596

For more details of critical accounting estimates, see Note 2(z) to the Financial Statements.

5. Dedicated Disclosure to Debentures Holders A. Rating

(1) Rating in Israel a) In November 2002, Maalot Israeli Securities Rating Company Ltd. (“Maalot”) announced

that it awards the highest ranking (AAA) to the Company. b) On November 22 2006, Maalot announced to the Company that it would be lowering the

ranking of the Company’s outstanding debentures from (AAA) to (AA+/Negative). c) In January 2008, Maalot sold all its operations to the international rating company Standard

& Poor's and changed its name to Standard & Poor’s Maalot (“Maalot S&P”). d) On December 30, 2008 Maalot S&P announced that it is including the rating of the

Company's debentures in its CreditWatch Negative list, in light of the risk involved in recycling the debt in 2009, due to the low liquidity of the Company, the aggressive investment plan of the company, the weak financial results and uncertainty about its operation, arising from delay of determining a new rates base.

e) On March 24, 2009, Maalot S&P announced that that it is lowering the Company debentures rating from (ilAA+) to (ilAA), while leaving the rating in its CreditWatch Negative list. On September 30, 2009, Maalot S&P announced that it is removing the Company from the CreditWatch Negative list.

(2) Rating Abroad

The Company was rated in 1996 by two international rating companies, Standard & Poor's (“S&P”) and Moody's, at (A-) and (A3) rating, respectively. Moody's: a) In January 2003, Moody's rating company lowered the Company's rating from (A3) to

(Baa2) with a negative forecast. b) In June 2005 Moody’s announced a change in methodology, which led to the Company’s

rating remaining at (Baa2) but the negative forecast was improved to a stable forecast. c) In October 2007, the Moody’s rating company published its periodic tracking report

announcing that the rating of the Company was (Baa2) with a stable forecast, but it rated the Company as a Stand Alone at (B2) which is not investible.

d) Moody's reconfirms the Company's rating periodically. The last reconfirmation of the rating was announced in June 2009.



54

5. Dedicated Disclosure to Debentures Holders (continued) A. Rating (continued)

S&P: a) In February 2003, S&P rating company lowered the Company’s rating from (A-) to

(BBB+/Negative). b) On January 17, 2008, S&P acquired the operations of the Israeli rating company Maalot.

This means that, as of this date, the ranking review and changes in ranking of the Company in Israel by Maalot and the ranking abroad by the international rating company S&P are correlated.

c) On December 30, 2008, S&P announced that that it includes the rating of the Company's debentures (BBB+/Negative) in its periodic CreditWatch Negative list..

d). On March 24, 2009, S&P announced that that it is lowering the Company debentures rating from (BBB+/Negative) to (BBB/Negative), while leaving the rating in its CreditWatch Negative list. On September 30, 2009, S&P announced that it is removing the Company from the CreditWatch Negative list

For more details on the rating of the Company, see the website of the Securities Authority www.magna.isa.gov.il.

B. Details of Debentures of the Group Traded in Israel

1) Details of debentures series 21 as at December 31, 2009, as required in the 8th addition to the Securities Regulations are as follows:



55

a) Series Debentures (Series 21) Issue date (initial) May 20, 1993 Total nominal value on the issue date (initial) NIS 220,000,000 nominal value.

(NIS 331,889,600) nominal value after exercising options

Nominal value on December 31, 2009 NIS 20,743,100 nominal value Revaluated nominal value in accordance with

linkage conditions for the report date (December 31, 2009)

NIS 43,215,764

Accumulated interest (as of December 31, 2009) NIS 201,674 Its fair value included in the last Financial

Statements The fair value of the marketable series in the stock exchange value, see below

Stock exchange value of debenture series on December 31, 2009

NIS 44,328,005

Interest type (fixed or variable) Fixed Interest rate 2.8% Principal payment dates 1/16 of the principal every October 31, of

each of the years 1995 – 2010. Redemption date – October 31, 2010

Interest payment dates Interest is paid every nine months on October 31 and April 30 of every year, starting from the initial issue date and up to the redemption date

Linkage basis Linked to the CPI of April 1993 It was determined that the debentures can be

converted to another security No

The entity is entitled to early redemption or enforced conversion of the debentures to other securities insofar that it exists and the conditions for exercising exist

No

A warranty was issued for payment of the entity's liability, in accordance with a trust deed

No



56

5. Dedicated Disclosure to Debentures Holders (continued) B. Details of Debentures of the Group Traded in Israel (continued)

1) Details of debentures series 21 as at December 31, 2009, as required in the 8th addition to the Securities Regulations (continued) b) Details of trustee for the liabilities - debentures (series 21):

a. Name of trustee company: Hermetic Ne'emanut 1975 Ltd.

Due to a conflict of interests, the trustee Ubank resigned his role as a trustee to holders of debentures Series 21. On December 16, 2008, Hermetic Ne'emanut 1975 Ltd. was appointed as a trustee for holders of debentures series 21.

b. Name of person responsible for the debentures series at the trust company:

Dan Avnon, Attorney

c. Contact details: Tel.: 03-5272272; Fax: 03-5271736 d. Address: 113 Ha'yarkon Street, Tel Aviv 63573

c) The debentures cannot be converted.

d) Rating of Debentures Series 21 by a Rating Company:

The rating company: Maalot S&P. The debentures series 21 of the Company was not rated on the issue date. In 2002, Maalot rated the Company's debentures at AAA. On November 2006, the rating was lowered to AA+ negative. On December 30, 2008 Maalot S&P announced that it has included the rating of the Company's debentures in its CreditWatch Negative list. On March 24, 2009 the rating of Company debentures was lowered from (AA+) to (ilAA) with a negative outlook and the debentures of the Company remained in the CreditWatch Negative list for another quarter. On September 30, 2009, Maalot S&P reconfirmed the rating of Company debentures (ilAA/Negative) and removed the debentures from CreditWatch Negative list. Regarding the rating of Company debentures, see paragraph 1 above.

e) Description of Assets Pledged to Secure The Liabilities of the Group with Respect to

Debentures To secure all full and accurate payments of the aforementioned debentures (principal, interest and linkage differences) and to secure proper compliance with the other terms of the debentures, the Company pledged all its assets in a floating charge and all of its rights to those assets of any type and sort whatsoever, which currently exist or will exist in the future, ranking equally with all other floating charges granted by the Company proportionately(pari passu) to the amounts of liabilities which will be secured, from time to time, by each of these charges. The Company is entitled to create additional permanent pledges on its assets in first priority right or in priority concerning the pledge to secure debentures from this issue. The trustee on behalf of the debentures holders consented in advance, that if the Company, at its discretion, will act to remove the current charges on its assets (except charges to secure new assets) and subject to receiving a commitment to place a negative pledge to his benefit (without derogating the right to maintain negative pledge for others), the charge to secure the debentures from this issue will be removed together with the other charges.



57


2) Details of debentures Series 22 as of December 31, 2009, as required in the 8th addition to the Securities Regulations are as follows:

a) Series Issue date (initial) May 29, 2002 Total nominal value on the issue date (initial) NIS 500,000,000 nominal value.

Nominal value on December 31, 2009 NIS 6,000,000,000 nominal value Revaluated nominal value in accordance with

linkage conditions for the report date (December 31, 2009)

NIS 6,964,251,060

Accumulated interest (as of September 2009) NIS 50,297,369 Its fair value included in the last Financial

Statements The fair value of the marketable series is the stock exchange value, see below

Stock exchange value of debenture series on December 31, 2009

NIS 7,992,000,000

Interest type (fixed or variable) Fixed Interest rate 6.5% Principal payment dates 1/12 of the principal every May 20, August

20 and November 20, of each of the years 2012 – 2014 and on February 20 of each of the years 2013-2015, starting from May 20, 2012 up to the redemption date on February 20, 2015

Interest payment dates Interest is paid every quarter on August 20, November 20, February 20 and May 20 of every year, starting from the initial issue date and up to the redemption date

Linkage basis Linked to the CPI of April 2002 It was determined that the debentures can be

converted to another security No

The entity is entitled to early redemption or enforced conversion of the debentures to other securities insofar that it exists and the conditions for exercising exist

No

A warranty was issued for payment of the entity's liability, in accordance with a trust deed

No

b) Details of trustee for the liabilities - debentures (series 22): Name of trustee company: Trust Company of Bank Leumi LeIsrael Ltd. Name of responsible person: Ms. Idit Twizer Address: 8, Rothschild Avenue, Tel Aviv 66881 Telephone: 03-5170777 Fax: 03-5170770 c) The debentures cannot be converted. d) Rating of Debentures Series 22 by a Rating Company:

The rating company: Maalot S&P. The Company's debentures series 22 was not rated on the issue date. In November 2002, Maalot rated the Company's debentures at (AAA). On November 2006, the rating was lowered to (AA+/Negative). On December 30, 2008 Maalot S&P announced that it has



58


2) Details of debentures Series 22 as of December 31, 2009, as required in the 8th addition to the Securities Regulations (continued) included the rating of the Company's debentures in its CreditWatch Negative list. On March 24, 2009 the rating of Company debentures was lowered from (AA+) to (ilAA) with a negative outlook and the debentures of the Company remained in the CreditWatch Negative list for another quarter. On September 30, 2009, Maalot S&P reconfirmed the rating of Company debentures (ilAA/Negative) and removed them from the CreditWatch Negative list. For rating of Company debentures, see paragraph 1a above.

e) Description of Assets Pledged to Secure The Liabilities of the Group with Respect to

Debentures No pledged assets.

3. Long Term Capital Sources

Over the course of the reporting period, a total of approximately NIS 3,496 million was raised from the following sources: NIS in millions Dentures issued in NIS 523 Debentures issued in US$ 2,072 Linked loans in NIS 260 Loans in foreign currency 641 3,496

4. Debentures and Liabilities to Banking and Other Corporations

The Company is a liability intensive entity with respect to loans and debentures. The balance of loans and long-term and extended term debentures as of December 31, 2009, without debentures to the State of Israel, is approximately NIS 42,465 million, detailed as follows:



59

5. Dedicated Disclosure to Debentures Holders (continued) B. Debentures and Liabilities to Banking and Other Corporations (continued)

Liabilities in Index-Linked NIS Millions of NIS Index-linked debentures in public offerings 13,904 Index-linked provident fund loans 1,605 Other index-linked loans (a) 915 Total Linked NIS 16,424

Non-linked NIS debentures in public offerings 657 Non-linked NIS loans 250 Total Non-Linked NIS 907 Dollar Linked Liabilities Money raised from a private offering for the sale of debentures in the US in US dollars

4,813

Loans in US dollars (b) 5,573 Money raised from a private offering for the sale of debentures in Europe in US dollars

642

Offering to institutional investors in Europe and the US, traded on the Singapore stock exchange, in US dollars

6,606

Total in US dollars 17,634 Money raised from a private offering for the sale of debentures in Japan in yen

3,473

Loans in euros 3,869 Loans in Swiss francs 20 Loans in pounds sterling 10 Total 42,337 Less discounts/premiums on debentures, current maturities, issuance expenses and hedge agreements, net.

(41)

Total debentures and liabilities to banks and others 42,296 Long term accounts payable 169 Total 42,465

(a) Including loans guaranteed by the State of Israel equaling NIS 639 million. (b) Including loans guaranteed by the State of Israel equaling NIS 5,269 million. * Regarding fund raising in 2009, see Note 18 c to the Financial Statements.

5. Long Term Credit Average as of December 31, 2009 – The credit was received from banks and others. The average credit for the reporting period was approximately NIS 46,296 million and consisted mainly of long term loans and debentures (including swap, hedge, postponed, premium and discounting of debentures transactions).

6. Short Term Credit Average as of December 31, 2009 – The credit was received from banks and others. The average credit for the reporting period was approximately NIS 4,192 million and consisted mainly of short term loans, overdrafts and current maturities of long-term loans.

7. Average Suppliers’ Credit as of December 31, 2009 - The average credit period for suppliers is approximately 38 days. Average credit from suppliers for the reporting period amounted to approximately NIS 1,277 million.

8. Average Customers’ Credit as of December 31, 2009 - The average credit period for customers is approximately 59.3 days. Average credit to customers for the reporting period amounted to approximately NIS 3,763 million.



60

6. Miscellaneous a. Indemnification Letter to Officers On December 24, 2009, the Company received an approval in principle from the State for issuing

an indemnification letter to officers of the Company (Member of the Company's Board of Directors who served in this capacity on the date of the formal submission of the Financial Statements of the Company as of June 30, 2009 ("The Determining Date"), the CEO of the Company, the CFO of the Company and the Legal Consultant of the Company, provided that they served in the said positions on the determining date.

In the indemnification letter, the Company undertakes to indemnify any officer for any liability or expense for which no indemnification was received from others: a. With respect to any direct or indirect action related to the preparation, approval and

publication of the Financial Statements of the Company as of June 30, 2009, unless the Company objects to the indemnification because the liability or expense is not related directly or indirectly to the correction of the error and the Director of the Government Companies Authority approves the position of the Company, after receiving the opinion of the Deputy Attorney General and the affirmation of the court.

b. With respect to implications of the correction of the error on the preparation, approval and/or publication of the Financial Statements and/or implications of the error correction on transactions related to or based on the Financial Statements of the Company preceding the determining date, all according to the terms specified in the indemnification letter.

The indemnification will not apply in the following cases: • Breach of obligation of trust, except breach of obligation of trust towards the Company, when

the officer acted in good faith and had a reasonable basis to assume that the act will not affect the benefit of the Company.

• Intentional or reckless breach of the obligation of caution, except when it is a result of negligence only.

• An act taken with the intention of deriving unlawful personal gain. • Indemnification with respect to paying a penalty or a fine imposed on an officer.

The cumulative sum of indemnification that the Company may pay to all officers according to this indemnification letter and according to all other obligation and indemnification letter to position holders (as implied by the Companies Ordinance – 1999) and to Company employees, issued or as will be issued by the Company in the future, including, if and as far as the Company will grant indemnification regarding restructuring and/or privatization of the Company, will not exceed 25% of the Company's equity, as of June 30, 2009, linked to the CPI in Israel, starting from the July 2009 index ("Maximum Indemnification Sum"). The Company's indemnification obligation will not apply to any sum which the insurer of the officer’s insurance policy has recognized as its responsibility and placed at the disposal of the officer on a date that enables him to fulfill the obligation imposed on him. However, when the officer is charged with an indemnifiable event in an amount exceeding the sum paid by the insurer, the indemnification will apply to the difference between the financial liability imposed on the officer and/or legal expenses expended by the officer or that were imposed on him and the sum received from the insurer for the same event, provided that the indemnification sum that the Company will be charged with according to this obligation letter will not exceed the maximum indemnification sum. The Company will also indemnify the officer with respect to the deductible that he will be required to pay according to the insurance policy. The obligation of the Company according to this indemnification letter will be valid from the determining date, namely from the formal submission of the Financial Statements of the Company as of June 30, 2009.



61

6. Miscellaneous (continued) a Indemnification Letter to a Position Holder (continued)

The obligation of the Company to indemnify a Director is a transaction with an interested party, by being an agreement between the Company and a Director in the Company regarding the terms of his position, therefore, approval of the Audit Committee, Board of Directors and the General Meeting is required according to the Companies Law.

The obligation to provide indemnification, in the version approved in principle by the State, was approved by the Audit Committee of the Board of Directors and the Board of Directors of the Company and the General Meeting of the Shareholders’ of the Company.

b. Evaluations of the Effectiveness of Internal Controls and Disclosure Controls

on the Financial Statement 1) In accordance with the directive of the Securities Authority, the Company was required in

2005 to prepare, in the spirit of the principles set in Section 404 of the U.S. Sarbanes-Oxley Act, reports concerning the Company’s controls with respect to actuarial commitments for the purpose of calculating pension liabilities, and fixed assets and fixed assets under construction.

The control reports have been completed, presented to the Securities Authority and publicly published. These reports included mapping the manual controls and IT systems and the examination of their effectiveness, including their strengths and weaknesses, as well as including recommendations to improve flaws defined as immaterial found in the inspections. All of the recommendations have been addressed by the Company.

2) According to Government Companies Authority Regulations (Additional Report on Actions

Taken and Presentations Made to Assure Correctness of the Financial Statements and the Board of Directors' Report - 2005) Government companies, including the Company, are required to attach to their yearly and quarterly Financial Statements an additional report concerning the activities taken and the presentations given so as to ensure full disclosure in the Financial Statements and the Directors’ Report. So as to implement this directive, the Company set up a system the purpose of which is to confirm and assess disclosure controls, information gathering processes and information processing for the Financial Statements. This so as to permit functionaries signing the Financial Statements and the Directors’ Report to declare in the additional report, that the Financial Statements and the Directors’ Report do not contain incorrect presentations of material facts and that they properly reflect in all material aspects the Company’s financial condition, operating results, changes in shareholders’ equity and cash flows as of the dates and for the periods presented in the reports.

The Company has set a procedure to confirm the lack of existence of weaknesses that may impact the report’s integrity, to implement all existing disclosure controls, among them implementing a systematic mechanism to manage and monitor information, to gather information from executives and statements of middle managers concerning the implementation of disclosure controls in their fields of responsibility, as well as applying appropriate controls to any changed work procedures.

3) According to Government Companies Authority Regulations (Additional Report on Actions Taken and Presentations Made to Assure Correctness of Additional Reports on the Subject of the Effectiveness of Internal Controls on Financial Reporting and the Board of Directors' Report) – 2007. Government companies, among them the Company, shall be required to attach to their annual and quarterly Financial Statements, starting with this report published as of December 31, 2009, an additional report concerning actions taken to ensure the correctness of the financial reporting, among them, establishing a system of internal controls, with the main purposes of: to examine the processes affecting the Company’s records which detail its transactions, to confirm the existence of controls and test their effectiveness and to ascertain with a reasonable level of certainty that Company receipts and expenditures are only made in accordance with the approval of properly authorized Company bodies.



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6. Miscellaneous (continued) b. Evaluations of the Effectiveness of Internal Controls and Disclosure Controls

on the Financial Statement (continued)

In the interim period, from the publication of the regulations until the date on which the attachment of the additional report will be required, the Company reported, as stipulated in the regulations, details of progress in preparations of the Company, including phases and timetables, for the presentation of an additional report. The Company completed the preparations for implementing its new requirements. Therefore, the Company engaged the firm of Ernst & Young to act as an expert guide and ensure correct presentation of the financial reporting. The Company established administration, control and work units. A steering committee, comprised of senior management functionaries and experienced consultants in the field was established and also a Control Committee and a work team. Roles of these committees and convening schedules were defined. The Company completed preparations required to implement regulations, the stage of application demarcation, making the required preparations in the Company for documentation and authentication of work processes and general controls of the information systems stage, and is currently conducting the controls authentication and resolving detected control gaps, except inspections and treatment of control gaps, if discovered, in the process of "closing a period and preparing Financial Statements", which will continue until the annual Financial Statement is approved, all according to the accepted methodologies and standards, the COSO and the COBIT model (for information systems), with the assistance of the expert and in full cooperation of the auditor of the Company. A dedicated computerized system was integrated in the project to implement the regulations in the Company, to manage the project and perform current on-going maintenance of the control upon completion of the project. The system allows documentation of risks and controls in any process, documentation of the performed tests and results thereof. The system also provided the ability to monitor faults corrections and to generate various control and administration reports.

4) a) On November 24, 2009, the Finance Committee of the Knesset approved an amendment

to the Securities Regulations (Periodic and Immediate Reports) - 1970 ("The Amendment"). This amendment requires all reporting corporations, that have securities registered for trade in the Tel Aviv Stock Exchange to declare the effectiveness of their internal audit of financial reporting and disclosure.

The amendment defines a roadmap for gradual implementation, requiring the Company to include in the periodic report for the year ending on December 31, 2010 ("The Starting Date") three disclosures on the following subjects: (1) A report of the Board of Directors and the Management of the Corporation on the

effectiveness of the internal audit of financial reporting and disclosure. (2) Declarations, signed by the CEO and the most senior finance position holder, stating

that to the best of their knowledge, the reports do not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements not misleading and that the reports fairly present, in all material respects, the financial condition, results of operations, changes in equity and cash flows of the Company. They must also declare that they disclosed to the Company's auditors and to the Company's Board of Directors and to the Audit Committee of the Company all significant deficiencies and material weaknesses in the design or operation of internal controls and any fraud, that they established such disclosure controls and procedures, designed to ensure proper financial reporting and disclosure and also reviewed the effectiveness of the internal audit.

(3) The opinion of the external auditor of the Company on the effectiveness of the internal audit.



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. Miscellaneous (continued) b. Evaluations of the Effectiveness of Internal Controls and Disclosure Controls

on the Financial Statement (continued) According to the directives of the amendment, the report of the Board of Directors

will include details on preparations made and progress on the Company in implementing the directives of the amendment during the period starting on the amendment publication date and up to the starting date.

b) Actions performed by the Company up to the report date for the year ending on December 31, 2009: (1) The Company commenced preparations for implementing the amendment at the end

of 2008. A preparations plan was outlined, including definition of the required work contents following the completions of a risks review on subjects of financial reporting and disclosure, scheduling of detailed timetables, defining managerial entities that will follow up the implementation progress, perform documentation, analyze gaps and conduct tests.

(2) The person responsible for implementing the amendment in the Company is the General Comptroller, Mr. Alex Zaid.

(3) The processes that are considered by the Company as highly material for financial reporting and disclosure in the consolidated statements were determined pursuant to conducting risk assessments of financial reporting and disclosure issues. The Company based its assessment on quantitative criteria derived from results of its operations and on quantitative criteria, that apply, inter alia, to the following issues: size and composition of accounts included in the accounting system, sensitivity to loss due to an error, contingent liabilities or fraud, operation scope, complexity and homogeneity of transactions included in an account or a disclosure, subjectivity level in an account or a disclosure, concluding transactions with related parties in an account and changes from previous periods in the properties of the account or the disclosure.

These processes are: (a) Inventory, with an emphasis on fuels inventory – coal, crude and diesel. (b) Procurement, with an emphasis on sub-contractors, fixed assets and payments to

suppliers. (c) Pension liability. The following processes were also included in the implementation framework: (1) The closing process of the financial statements and the disclosure. (2) Top level controls and audits. (3) General control and audit of the information systems processes.

c. Events During the Reported Period

1. The Company has presented an indemnification claim to the Disengagement Administration with respect to Company fixed assets left behind in the Gaza Strip following the Disengagement, in accordance with the Disengagement Plan Implementation Act of 2005. The indemnification, in the amount of approximately NIS 25 million (in accordance with the value of property on the Company's books has been received in February 2009.

2. The Government Companies Authority has approached the Company to act to refund funds (some NIS 3 million) which it claims were not properly paid to Company employees in areas near Gaza. The Company has repeatedly approached the Government Companies Authority to cancel this demand and to hold an additional inquiry on the subject.

3. For the purpose of supervising and controlling Company funds transferred to the Workers’ Organization, the Company entered an agreement with an external auditors firm that controls Company funds transferred to the Workers Organization. The Company transfers between NIS 10-15 million per year to the Workers’ Organization to participate the funding of its current activities.



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6. Miscellaneous (continued) c. Events During the Reported Period (continued)

4. On May 14, 2008, the Company’s Board of Directors approved in principle the outline of the restructuring plan, presented to the Board of Directors by the CEO of the Company.

The plan is based, inter alia, on the retirement of some 2000-2500 employees and a process of reducing the number of Company employees over a period of three years, on restructuring Company units, including a reduction in managerial control, consolidation of functions benefiting from economics of scale, elimination of duplications and creation of supportive management mechanisms aimed at improving processes, management flexibility and optimal utilization of resources and manpower.

In a preliminary estimation by Company Management, the total cost of the plan amounts to some NIS 2.3-4.0 billion. Under the instructions of International Standard No. 19, conditions are not yet ripe to recognize the expected costs with respect to the plan (except employee's retirement. See Note 19 (a)(2)(d) to the Financial Statements).

The Board of Directors instructed the CEO of the Company to open intensive discussions with the workers representatives as quickly as possible, as required by law, in the matter of the rights of the employees. The employees' organization announced that they object to the implementation of the plan and have prohibited any cooperation in this matter on the part of the employees (see Note 24 c to the Financial Statements). At the same time, the Management and the workers' organization agreed at the beginning of May, to open discussions on the restructuring of the electricity sector and structural change and efficiency process in the Company and open negotiations on resulting workers rights, supposed to be completed up to August 1, 2009, aiming to reach an agreement on the aforementioned changes. On September 16, 2009, the Board of Directors decided unanimously to enable effective negotiations between the Company, the State, the Histadrut and the employees organization without a time limit, to consolidate an agreed upon outline of an organizational restructuring of the Company and a restructuring of the Electricity Sector. Due to various arguments with the employees organization and the Histadrut, the negotiations were not opened as yet.

5. On June 24, 2008, a wage agreement was signed for the period up to December 31, 2009.

According to the signed agreement, the wage increment is of 5%, to be paid as follows: 1.5% in January 2008, 1,5% in December 2008 and 2% in December 2009. For further

details, see Note 19 a(2) to the Financial Statements.

6. On January 28, 2009, the Company issued debentures through the investment banks Citi Group and J. P. Morgan to institutional buyers in and outside the U.S.A. of a total sum of U.S.$ 500 million, nominal value, out of a general plan (GMTN) to issue debentures of a total amount of up to U.S.$ 2 billion nominal value. This issue added to a previous issue of May 2008, in the amount of U.S.$ 1 billion nominal value, thus adding up to a cumulative sum issued under the general plan of U.S.$ 1.5 billion nominal value. These debentures were registered for trade on the Singapore Stock Exchange. The debentures were issued at a nominal interest rate of 9.375% (effective interest rate of about 9.5% per year with respect to annual payments and effective interest of about 9.7% per year with respect to semi-annual payments). The principal of the issued debentures will be paid off in one payment on January 28, 2020.

7. On February 12, 2009, the Company issued through Leader Capital Markets Investment

House, by way of a private placement of non-marketable, linked debentures, Series "Linked Electricity 2020" at a nominal value of NIS 505 million, at a nominal interest rate of 6.85% (effective interest rate of about 7.1% per year with respect to semi-annual payments). The principal of the issued debentures will be paid off in one payment on February 12, 2020.



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8. On March 31, 2009, a NIS 250 million loan was received, linked to the CPI at a nominal

interest rate of about 4.5% (effective interest of approximately 4.6% per year with respect to semi-annual payments). The loan will be paid off in one payment on March 31, 2020.

9. On July 7, 2009, the Company received the decision of the Public Utilities Authority - Electricity made on June 29, 2009, updating a previous decision made on October 30, 2008, on the event of failure to meet timetables of the emergency plan for the construction of power stations. See also Note 3(e)3 to the Financial Statements as of December 31, 2009.

10. On July 23, 2009, the Tenders Committee of the Board of Directors of the Company approved an agreement in principle with Thetis Sea Group for purchasing additional quantities of natural gas, from the group. See also Note 24(a)(2) to the Financial Statements as of December 31, 2009.

11. Under the Request For Quotes process in 2007, the Company held clarification talks with the partnership in "Tamar" natural gas drilling site.

Pursuant to these clarifications, the Company's Board of Directors approved on Thursday, December 24, 2009, the beginning of an exclusive negotiation with the partnership on purchasing natural gas from "Tamar" field, to be based on the principles of the non-obligatory letter of intentions between the parties of December 13, 2009, on the purchase of at least 2.7 BCM of natural gas per year for a period of 15 years, starting on July 2013. For more details, see Note 24(a)(f) to the Financial Statements.

12. On August 23, 2009, the Company announced that the Audit Committee and the plenum of the Board of Directors of the Company approved an amendment to the agreement of 2005 for the supply of natural gas between the Company and East Mediterranean Gas S.A.E. For more details see Note 24 (a)(3) to the Financial Statements.

13. A notice on a strike was submitted on May 26, 2008, according to the Settlements of Labor

Disputes Law with respect to the intention of the employer to implement a comprehensive organizational change and an efficiency plan, with significant and critical impact on the employees in all aspects. On January 1, 2009, the CEO and the employees committee reached understandings on the implementation of some of the steps of the Matzpen plan and conducting intensive negotiations about subsequent steps. The negotiations failed and subsequent various sanctions were commenced on March 12, 2009. For details of the costs incurred with respect to this issue, see Note 1(k) to the Financial Statements. The Company intends to appeal to the Electricity Authority to receive rate coverage for these damages. On April 26, 2009, after several hours of unsuccessful attempts to reach an agreed upon course of understanding between representatives of the State, the workers organization and the Company, another discussion was scheduled for May 3, 2009.

On May 3, 2009, the Management and the workers organization reached understandings that will remain in force up to August 1, 2009, or up to a later date, as agreed upon by the parties, relating mainly to the suspension of the Matzpen plan and reverting the situation related to Matzpen plan to its status on the eve of February 15, 2009, removing all sanctions and returning immediately to full normal work routine. A letter, delivered earlier, on April 30, 2009, from the CEO of the Ministry of National Infrastructures and the Manager of the Companies Authority, addressed to the CEO of the Company and to the Chairman of the workers organization, announces their intention to conduct discussions on the restructuring of the Company with the parties and negotiate the workers rights under the restructuring plan. See Note 24(c) to the Financial Statements for additional details on this and other labor disputes.



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14. Following publication of data from the Financial Statements for 2007 in newspapers prior to

issuance to the public, and pursuant to the requirement of the Securities Authority, the Company appointed on June 10, 2008, an attorney, Moran Meiri, of the firm of Matri, Meiti & Co., Attorneys at Law, as an external investigator to examine the leakage of data from the Financial Statements to the media.

The law firm submitted the investigation report on July 23, 2008. The primary findings include deficient "organizational practices" in the Company regarding

all matters related to leakage of confidential and internal information to unauthorized parties. The external investigator also suggested several steps the Company should take to prevent

recurrence of similar events in future, which were adopted by the Board of Directors of the Company.

The CEO appointed a team, for implementing the recommendations of the external investigator. The team presented its conclusions to the Company's CEO and Board of Directors on January 8, 2009 and the Company started to implement these conclusions.

Moreover, by force of the decision of the Board of Directors, made on September 17, 2008, and as required by the Securities Authority, the attorney, Moran Meiri, was appointed on October 23, 2008 to conduct an investigation and attempt to locate the source of data leakage from the Financial Statements for the second quarter of 2008 ("The Financial Statements") and employ for this purpose all the available legal means, including polygraph tests.

On August 6, 2009, attorney Moran Maori, presented the findings of the investigation to the Board of Directors of the Company, including polygraph tests conducted for 36 members of the Board of Directors, managers and Company employees.

The Company takes a stern view of these leaks from the Financial Statements and intends to act as follows: a. Continue to enforce the recommendations of the first report on the review conducted by

the attorney Moran Meiri on ways and means that the Company should employ to prevent recurrence of similar events in future and continue enforcing procedures defined in accordance with the recommendations of Moran Meiri.

b. To exhaust the disciplinary process conducted against an employee of the Company who refused the demand of Moran Meiri at meet with him.

c. Appeal to the Government Companies Authority and ask for directions on actions the Company should take with respect to the report and its results.

d. Appeal to the Securities Authority and ask for directions on actions the Company should implement with respect to the report and its results.

15. The following are appointments and completion of service terms that occurred during the

report period: - On January 1, 2009, Mr. Zecharia Kay was appointed Manager of the Finance Division. - On January 4, 2009, Ms. Pnina Dvorin ended her term of service as a Director of the

Company. - On January 11, 2009, Mr. Tzvi Harpak was appointed Deputy CEO Organization &

Logistics, Security and Emergency. - On February 12, 2009, Mr. Raphael Edery ended of his term of service as a Director of

the Company. - On March 31, 2009, Mr. Yosef Shnek was appointed Manager of the Information and

Telecommunication Systems Division. - On May 19, 2009, Mr. Amit Lang ended of his term of service as a Director of the

Company. - On May 19, 2009, Ms. Stella Handler ended her term of service as a Director of the

Company. - On August 2, 2009 Company's Board of Directors appointed Mr. Shay Rosenstock, CPA

as the Internal Auditor of the Company.



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- On August 7, 2009, Mr. Yosef Vadana ended his term of service as a Director of the

Company and was reappointed on September 22, 2010 for another term. - On August 7, 2009, Mr. Dov Oren ended his term of service as a Director of the

Company. - On December 2, 2009, Mr. Ziv Reich was appointed as an external Director of the

Company. - On January 6, 2010, Mr. Gideon Frank was appointed as a Director of the Company. - On January 6, 2010, Ms. Rochelle Don-Yechiya was appointed as a Director of the

Company. - On January 6, 2010, Mr. Shimon Eckhaus was appointed as a Director of the Company. - On January 14, 2010, Mr. Natan Avraham was appointed as a Director of the Company. - On February 17, 2010, Ms. Aura Sova-Gindin ended her term of service as a Director of

the Company. - On February 17, 2010, Ms. Yaffa Vigodsky ended her term of service as a Director of the

Company and was reappointed on February 21, 2010 for another term. - On February 20, 2010, Mr. Mordechai Friedman ended his term of service.

d. Appointing External Auditors

1. In accordance with the decision of the General Meeting No. 85 on December 31, 2008, the appointment of the Brightman Almagor Zohar & Co. auditing firm as the Company's external auditors was reconfirmed for the period starting January 1 2009 and up to December 31, 2009, subject to the approval of the Government Companies Authority. The Government Companies Authority approved the said appointment on March 1, 2009, provided that the external auditor will act on all matters relating to the fulfillment of his duties in accordance with the law and the circulars of the authority.

2. As specified in the decision of the General Meeting, the Company's Board of Directors implemented all the directives included in the circulars of the Electricity Authority (as published from time to time) on procedures of employing external auditors and setting their fees and on the Financial Statements (audited, reviewed, budget), reports of the Board of Directors and external and Internal Audit execution reports.

e. Rewards to Position Holders

According to guidelines of the Government Companies Authority, the Board of Directors of the Company is entitled to approve a personal reward pursuant to an excellence test to the CEO and to senior employees, up to a limit of 10% of their salaries for the period. The Board of Directors of the Company decided to grant an annual reward to the Chairman of the Board of Directors at the rate of 10% of his salary for the period, for the period from March 1, 2007 (upon assuming this role) and up to December 1, 2008, in appreciation of his being an active, full time chairman who devotes most of his time and efforts to work in the Company. On December 9, 2009, the Board of Directors decided to approve a personal reward to the Chairman of the Board of Directors at a 10% rate of his periodic salary, for the period from January 1, 2009 and up to February 21, 2010. These decisions were approved by the General Meeting of the Company. The Board of Directors also approved on May 31, 2009, payment of an annual bonus to the CEO of the Company, Mr. Amos Lasker, in accordance with an excellence test, at the rate of 10% of his periodic salary, for the period from April 1, 2008 up to March 31, 2009.



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6. Miscellaneous (continued) f. Risks Management

In accordance with the Government Companies Authority Circular from June 11, 2009, enclosed herewith a description of the significant risks of the Company.

Effect Risk Type

Category

Sub-Category


Moderate Moderate effect on Company objectives

Low Minor effect on Company objectives

1. Damaged image X 2. Natural gas supply

and delivery Failure/ damage to the natural gas supply and the natural gas delivery system

X

a. Strategic Risks

3. Natural disasters (earthquake/ flooding/ storm) and fires

X

4. Security events War X Terror X 5. Geopolitical

situation Dependence on foreign sources

X

6. Competition Entry of new operators and renewable energies

X

7. Unrealized forecast long term demand

X

1. Compliance risks Permits and Licenses X b. Compliance and regulation

2. Regulatory risks The Company is exposed to strict regulatory demands required by different parties: The Ministry of National Infrastructures, Government Companies Authority, Electricity Authority, the Ministry of Finance, the Ministry of Environmental Protection, the Ministry of Labor, the Securities Authority

X

Information Technology

1. Failure of the information systems

X

2. Information security - hacking into the system

X

3. Environment X c. Operational

4. Safety Employees and third party safety

X

Risks Human Resources 5. Labor relations X 6. Human errors X 7. Knowledge Knowledge management

and retention X

8. Supply chain X 9. Strategic suppliers X 10. Generation X 11. Embezzlement and

fraud X

12. Failure to fulfill the development plan

X



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6. Miscellaneous (continued) f. Risks Management (continued) Effect Risk Type

Category

Sub-Category


Moderate Moderate

effect on Company objectives

Low Minor effect on Company objectives

Market Risks 1. Exposure to changes in exchange rates of foreign currency for the balance of loans

X

2. Exposure to market risks in pension fund investments

X

Liquidity Risks 3. Financing the development plan

X

d. 4. Obligations to lenders X Financial 5. Funds raising ability X Risks 6. Capital structure X Credit and securities

risks 7. Banks risks X

8. Doubtful/bad debts X 9. Legal Class actions X 10. Income Rate determined does not

cover Company costs X

11. Financial Statements and internal audit risks

X



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6. Miscellaneous (continued) f. Risk Management (continued)

1) Strategic Risks

a) Damaged Image

Over the years, Company’s image has been perceived as medium to low, with the accumulated public discontent acting against it in almost every aspect and reflecting in its treatment by all of the relevant functions: decision makers, opinion shapers, decision makers and the general public - Company customers of all kinds. Under these circumstances, the Company’s image has become a stumbling block in its posing a number of difficulties at every level and in all of the environments within which we operate. The current image perception creates an “image deficiency” representing a gap between the actual qualities, professional capabilities and high level service provided by the Company and the way the public views it. In recognition of its importance and implications, improved image was defined in late 2008 as a strategic goal of the Company. A good company poorly viewed will find it difficult to operate in a hostile environment and may suffer considerable damage.

b) Failure/Damage to the Natural Gas Supply and the Natural Gas Transportation System

On transition to the use of natural gas in combined cycle power stations as well as in steam fired power stations adapted for natural gas firing, the Company is exposed both to failures in the natural gas supply provided by the various gas suppliers and to breakdowns in the marine nautral gas transportation pipelines along the coastal plane from Ashkelon in the south to Dor beach in the north and/or in the surface gas transportation pipelines and PRMS plants. Such potential breakdowns and the inability to store natural gas in its own facilities leave the Company exposed to increased costs associated with alternative, more expensive fuels. The contracts signed with the natural gas suppliers and the natural gas transportation system operator allow limited compensation for such damages, which does not cover the Company’s total potential damage.

c) Natural Disasters

Earthquake Under the emergency plans of both the local and the world emergency authorities, power stations are defined as vital lifelines in the provision of immediate response and rectification of an incident. As a part of its preparation for an earthquake incident, the Company has developed a software application serving to assess damages inflicted on the power stations by an earthquake based on advanced earthquake risk assessment methods accepted globally, and has investigated the implications of high probability, maximum intensity scenarios. These scenario assessments serve as a basis for earthquake drills designed to evaluate and increase the level of readiness. A reference scenario drill was run in 2009, whereby an earthquake incident is outlined (location and intensity) along with its implications on Company facilities, electrical system, transportation infrastructures and personnel. Also evaluated was the resistance of strategic transmission lines (“red” and “orange” lines) under the impact of an earthquake and was found to be earthquake proof Fire Company facilities securing the electricity chain and other Company facilities such as office buildings, workshops, garages and warehouses are plagued with fire hazards originating in the flammable and toxic materials stored on the premises alongside with numerous sources of ignition.



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1) Strategic Risks (continued)

Since power stations feature stored fuels and operations involving flames, high temperatures and high pressures, the fire hazards they entail are considerably greater than in other facilities. For example, a fire breakout will stop a number of generation units and induce consequential damages due to operating a power station using higher cost fuels – all in addition to any direct damage as will result from the fire, including the costs of cleanup, repair, replacement of units and clearing of all waste and pollutants. The greatest fire damage would be that which is caused by the fire reaching the boilers and turbine halls of two large and adjacent coal fired units. All direct and consequential fire damages are covered under Company’s purchased All Risks insurance. Major Company facilities are fitted with sophisticated fire detection and control systems designed and installed under strict Israeli and international standards. These systems are serviced by trained and qualified professionals, and they are activated at recommended intervals to check for normal operation. The Company employs professional firefighters and site emergency teams, all subject to training and drills to preserve their skills. The Israel Fire Emergency Service runs periodic audits on Company sites where the existing fire detection and control systems are evaluated for design, construction and maintenance, unreasonable fire hazards and site personnel readiness for fire prevention and control. Joint drills are also run with the Emergency Services in order to evaluate the level of cooperation and to practice the operational capabilities required to extinguish large scale fires. Flooding Many Company sites have cellars which would have filled up with rainwater had it not been for the draining systems installed to prevent this. These cellars are common in power stations, substations and transformer stations. Under extreme conditions when the amount of rainwater exceeds the capacity of the drains or where the drains are clogged, a flooding risk arises. Flooding impairs plant operation and may induce direct and indirect property damages. To minimize the effect of such risk, draining systems design, construction and maintenance are inspected before the raining season starts. Storm The Company prepares for extreme weather scenarios which include storms and strong gusts of wind which may damage strategic transmission lines. To minimize the risks, the Company takes the following measures: − Increased maintenance of strategic ( “red” and “orange”) transmission lines;

− Annual ERS emergency pylon network activation drills;

− Emergency stocks of pylons and network fittings;

− Operation of an alternative supply bypass system for emergencies.

In Company’s estimation, the strategic transmission lines are not subject to any snowstorm hazards. Based on risk surveys as run periodically by qualified surveyors, the Company purchases insurance coverage for damages resulting from natural disasters (earthquakes, floods and storms) and from fires, which amounts to 1 billion US dollars per incident.



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d) Security Events

War As an essential service provider, the Company is obliged under decrees of the State of Israel to prepare for any war hazard. The Company’s CEO serves as Head of the Assigned Electricity Authority. As such, both he and the Company he heads are obligated under the Defense Ministry instructions (National Emergency Authority) to supply electricity to the State of Israel also in times of emergency. The Company is subject to the Civil Defense Law and must therefore follow Civil Defense and Israeli Police instructions and prepare for a war emergency. The Company’s control and preparations for war emergencies include analysis of a reference wartime scenario, running of drills, construction of equipment stocks and setting up of operational headquarters. Preparation are accomplished under instructions by the National Emergency Authority. Terrorism Under Israeli Government Decree B-84, Critical Infrastructures, and also under the Secured Organizations Defense Regulation act, the Company is obligated to secure all of own personnel and facilities against any disruption of its routine operations. By force of this act, Israel Police instructs Company’s security officers to run all security operations using skilled personnel and advanced technologies in the prevention of various acts of terrorism which directly affect both the Company and the national security (mass killings, car bombs, demolition charges, heavy damages to essential national infrastructure targets, shooting, suicide bombers etc). The Company established a security procedure in Company facilities, that will enable the Company to supply electricity both in lull times and in emergencies, and to secure all of own personnel and visitors on its various sites. The insurance policies purchased by the Company normally exclude damages originating in terrorism or war. These damages should be covered under a special state fund allocated for terrorism and war damage compensations and subject to the Property Tax and Compensation Fund Act. It shall be noted, however, that the Company disagrees with the Property Tax Authorities on the payment of direct war damages, the issue is currently under legal consideration.

e) Geopolitical Situation – Dependence on Foreign Sources

The Company supplies electricity to Israeli residents with no option to purchase electricity and/or backup by other local or overseas suppliers, all because of the prevailing geopolitical situation in the region. The various fuels employed by the Company in the power generation process as well as a large proportion of the equipment required by the various Company facilities are purchased, either directly or indirectly, from foreign sources. A substantial amount of the fuel and equipment is purchased under time limited contracts. Since it is so largely dependent on foreign sources, the Company is exposed to numerous risks, such as delayed equipment or fuel supplies as may result from political instability, embargos, port strikes and other such occurrences. Any disruption in the supply of the various fuels employed in the generation of power compromises both the financial state of the Company and its reputation. To prevent extensive damage and disruptions of supply, the Company maintains reserves of the various fuel types serving in the generation of power.



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6. Miscellaneous (continued)

f. Risk Management (continued) 1) Strategic Risks (continued)

f) Competition – Entry of New Operators and Renewable Energies

As of the date of this report, the Company generates, transmits and supplies most of the power consumed within the State of Israel. Since it is a stated Government policy to allow competition in the electricity sector, the Government set the goal of increasing power generation by private electricity producers from 0.65% to 20% of the country’s power generation capacity. Although the Company feels this goal is not to be attained any time soon in view of the currently very small generating capacity of the private electricity producers and the long time it takes to set up the equipment required for power generation, there is no guarantee that Company’s estimations in this regard are true. Also, the Company believes that increased use of natural gas in the generation of power may accelerate competition in the electricity sector since natural gas fired generation units are considerably cheaper to construct than coal or liquid fuel fired ones. The instructions of the Electricity Sector Law are designed to promote the structural change of the Israeli electricity sector, including those which concern the construction and operation of subsidiaries sharing the same business lines with the Company so as to encourage competition in the electricity sector. Under the Electricity Sector Law and Orders, holders of transmission licenses are required, inter alia, (a) to purchase power from private electricity producers (with the purchase periods and amounts subject to the type of the relevant private electricity producer), (b) to allow private electricity producers to sell power to their customers through the Company’s transmission network and supply mechanisms, and (c) to provide customers of the private electricity producers an alternative supply source. There is currently an uncertainty with regard to the regulations set by the Minister of National Infrastructures and to the criteria set by the Electricity Authority with respect to preferences which may be given to private electricity producers over the Company. The growth potential of the competition poses a financial risk to the Company since it introduces an element of uncertainty with regard to the amount of electricity the Company will be required to produce in the future. Should the electricity projects of the private electricity producers as currently planned not be realized, the Company will still be required to supply the amount of electricity which would have been supplied by such projects. The Electricity Authority has made some decrees which were designed to encourage the penetration of private producers in the market while providing them a rather expansive safety net. In its Order of October 26th, 2008, the Authority established that, for each private electricity producer, the Company should deposit in a designated account a sum of money which equals a bimonthly payment for the power expected to be sold to the Company by that producer. These sums, which would not be included on the list of Company’s pledged assets, shall serve to secure payments to the producer. Also established were a rate agreement to apply between the private electricity producer and the vital service provider on occurrence of a force majeure, safety event or change to a discriminating law, and a rate agreement as derived from the division of the responsibility between the parties to the purchase transaction. This decree holds the essential service provider responsible for producer’s compensation by various payments on the occurrence of a force majeure incident which would delay or preclude the purchase transaction as well as for damages to the producer’s facility as may be due to an action of omission by the natural gas transportation company. In its Order dated December 8th, 2008, the Authority set a rate agreement for a conventional private electricity producer in a transaction of selling available capacity and energy to the system manager. In such a transaction, the producers will have the right to make some (or all) of the available generation capacity of their stations available to the



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system manager, for which the system manager will commit to a predefined amount of gas. The system manager will be liable for the relative share in producer’s gas transaction whether or not it will be used in effect. On April 21st of 2009, the Authority published a hearing document with regard to the proposed revision to Criteria Section E, which covers the infrastructure services provided by an essential service provider to suppliers and customers, and Section F, which covers producers’ dealings with the system manager in availability and energy purchase transactions. These criteria regulate essential service provider and system manager dealings with facilitators and private electricity producers. Under the proposed document, private transactions in the electricity economy will be accomplished through the facilitator whose central function would be that of a commercial organization mediating among the market players. These decrees will impose numerous costs on the Company, which will rise still as private electricity producer operations expand and which the Company cannot quantify at this point in time. These costs may well be recognized by the Electricity Authority, however the Authority is yet to publish any explicit statement to this effect and therefore the extent of exposure suffered by the Company to such costs is unclear. Under the assumption that the structural change will have the generation segment split among a number of companies, these companies may encounter competition by private electricity producers who will penetrate the market. The Company believes that if such change is indeed effected, the electricity producing companies formed out of the split will be able to make use of Company’s extensive experience as well as its human and physical capital to compete in an optimal manner. Yet, since there is no telling how such producing companies will operate, it remains to be seen whether they will compete with the private electricity producers on equal terms or be given a lesser preference compared with the private electricity producers. Nevertheless, since the Company operates in a regulated market, the introduction of private electricity producers in the market will not expose the Company to any risk of competition. Despite all the aforementioned, there is one other aspect which poses a potential risk – the potential breakthrough in the miniaturized power generation technologies, in which extensive resources are invested worldwide. The launch of a Smart Network program as a strategic project of the Company allows the Company to preserve its organizational and professional capabilities, to support and control the penetration of such technologies if they emerge, and also to develop a business horizon which will substitute any lost incomes as it may suffer should miniaturized energy production assumes a mass production effect.

g) Unrealized Forecast Long Term Demand

Under the Electricity Sector Law, the Company is not responsible for the development of the electrical system. However, in effect, it is indeed responsible for the supply of reliable and available electricity. This is why it must see to the development of the generation, transmission, transforming and distribution systems. Future development relies on a number of factors: future market demand forecasts, the geographical distribution of the predicted demand, development of production technologies and means, supply forecasts for the various fuel types, environmental limitations, development of existing and new sites, the current and predicted geopolitical situation, and forecasts of private electricity producers penetration in the electricity sector.



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The larger the number of the prediction parameters is, the greater the uncertainty and difficulty of prediction become. The Company relies on these demand forecasts when it makes monetary and resource investments, raises capital and sets up facilities. If the forecast is higher than the actual demands, then Company’s existing means may not cover the future demands. If it is lower, then the Company may enter into debts which it will not be able to pay since the facilities constructed will become obsolete. The controls serving to minimize the damage which will result from under prediction or increased demand include project integration and facilitation, use of bridging projects and launching of emergency projects. The controls serving to minimize the damage which will result from over prediction or reduced demands include delayed or cancelled equipment purchases, and (amount and time) flexible supplier contracts. Additional damage controls are Company’s experience, short and long term development plans, and prudent capital raising policy.

2) Compliance and Regulatory Risks

a) Permits and Licenses

The Company was granted licenses under the Electricity Sector Law for the transmission, supply, distribution and trading of power, as well as separate power generation licenses for the various units. These licenses regulate all Company’s operations, however they also impose additional limitations thereon. For example, the Electricity Sector Law requires the Company, where so requested by the Minister (in consultation with the Electricity Authority), to submit for Minister’s authorization a full or partial development plan, and the Minister, in turn, is authorized to establish, in consultation with the Electricity Authority, a development plan for the Company on Company’s failure to submit own development plan at his request. Also, the licenses may be revoked or modified before termination as provided under the Electricity Sector Law instructions and license terms. Under Amendment 8, subsequent extension of the licenses does not required Knesset legislation but can rather be effected for 1 year periods at a time under authorization by the Minister of National Infrastructures and the Finance Minister, in consultation with the Electricity Authority and the Companies Authority, and subject to authorization by the Economic Affairs Committee of the Knesset. So far, the licenses were extended soon before they expired, and, on December 31st of 2009, they were extended until January 1st of 2011 under the Electricity Sector Order (Dates Postponement) - 2009, however there is no telling whether or not new licenses will be granted or existing licenses extended in future, and whether or not the terms of the new licenses will remain the same as the existing ones. Based on past experience, the Company estimates that the licenses will indeed be extended. In addition, there is no certainty that the existing control and licensing instructions of the electricity economy will not be changed in the future. Also, beyond the requirements of the Electricity Sector Law as related to the incorporation of operations under subsidiary organizations, the Company cannot predict what changes will be made with regard to licensing and other control provisions when the license extension periods as established under the Law for the licenses granted to the Company by force of the Electricity Sector Law are up. If the licenses are not extended or if the licenses or other control provisions are changed, the Company or its financial state may be adversely affected.



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2) Compliance and Regulatory Risks (continued)

b) Regulatory Risks

Beside the regulated electricity rates, the Israel electricity sector as well as Company’s operations are subject to extensive control as required, inter alia, under the Electricity Sector Law. These regulatory instructions relate to licensing, competition, rates and environmental requirements, to name a few of the concerns. The legal environment within which the Company currently operates comprises the Ministry of National Infrastructures, the Government Companies Authority, the Public Services Authority – Electricity (establishing the electricity rates and criteria), the Ministry of Environmental Protection, the Ministry of Internal Affairs, the Planning authorities and the Israel Antitrust Authority. The Company is not certain that the cost associated with the application of the stringent regulation as above and that the unique characteristics of the electricity authority and other factors as above will not adversely affect Company’s business outcomes, operations and financial state. The Company is also subject to extensive control under the Government Companies Law of 1975, the Securities Law of 1968 and the Antitrust Law of 1988.

3) Operational Risks

a) Failure of the Information Systems

The Company’s business processes are supported by information systems in the following pursuits: (1) Electricity chain – power generation and supply;

(2) Business/financial – financing, financial statements, collection, supplier payments, planning;

(3) Customer service – hotline 103, website.

Failure of any of the information systems supporting these processes will disrupt the processes and damage Company’s financial state and reputation. The Company’s array of computer systems is based on two reciprocally backed-up computer centers (in Tel Aviv and in Haifa). Physical backup of all data is provided on a remote site, with critical systems also backed up synchronously. A two way backup drill is run once annually between the two computer centers, where preventive actions are also taken to prevent failures. These include upgrading of the physical infrastructure and the electrical system, periodic testing of the supporting systems (UPS, generator, structure control system, flood detector and firefighting system). Failure scenarios are provided for all systems defined critical. These scenarios are drilled and updated under an emergency drills program (covering earthquake, war and other emergencies) as implemented by the Company.

b) Information Security – Hacking into the System

System hacking using a hostile code may disrupt and damage the information systems as well as the normal operation of the systems supporting Company’s business operations. Moreover, system penetration by a hostile code may damage the management network, leak data out to unauthorized functions and impair data integrity. Hostile codes may be entered and the network penetrated through web surfing, incoming emails, network breaching or contaminated storage facilities.



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3) Operational Risks (continued) To prevent system break in, routine actions are taken and controls are effected as listed below: A secured solution for web surfing, a protective package for end stations and servers, an antivirus application for surfing purposes, a barrier to block out unrecognized components, and an email traffic control system. The Company also acts to increase personnel awareness to data security through a dedicated data security campaign. The management network is separated from the operational network, with data transferred one way only – from the operational to the management network, using a dedicated tool. The Information Systems Division has been accredited to data Security Standard ISO-27001, which accreditation serves as additional control of the Division for compliance with the various requirements to reduce Company’s data security risks. Company’s computer equipment is covered similarly to other operational assets of the Company under an All Risks insurance which includes profit losses/increased fuel expenses as may result from damage to the computer systems.

c) Environmental Protection

Company’s operations are subject to various environmental laws and regulations as related to air and water pollution, noise prevention, non ionizing radiation, storage, transportation, disposal of toxic and other dangerous materials, and control of ground pollution. Some of these laws are in effect at the date of this report, while others are still in the making. The Company estimates that these laws and regulations may become more stringent still in the future, and that additional laws may be set forth down the road. In the Company’s estimation, it basically meets all legal and regulatory environmental requirements at the date of this report. It is also now studying the implications of any proposed environmental laws and regulations, and allocates under own development plan and operational budget funds to finance the pursuit of the existing and forthcoming legal and regulatory environmental requirements. The Company feels that any expense it will be compelled to suffer so as to comply with the proposed environmental laws will be recognized by the Electricity Authority in the rates. Yet, the costs to be suffered by the Company under the existing and/or new laws may be substantial. The Company acts to minimize the environmental effects of its operations in compliance with its governing laws and standards. These actions include the construction of pollutant emission reducing facilities and the transition to natural gas firing of power generation units.

d) Employee and Third Party Safety

The Company’s safety activities are subject to the following Government Laws: (1) Workplace Organization Law;

(2) Workplace Safety Regulation.

Company operations are run under work procedures and safety instructions designed to protect Company personnel on Company sites and which cover both the various risks and hazards associated with the work environment and the protective equipment required. Also provided are the (legally required) personnel refresher training programs covering workplace hazards, and the various protection and control measures to be taken to minimize the damage induced by a safety event. Safety managers on the various Company sites run supervisions and surveys to identify and control the hazards.



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3) Operational Risks (continued) The distribution and transmission networks are maintained under the national network procedures which specify the scope and frequency of audits and also the technical parameters identifying the state of the facilities so as to allow early identification and rectification of safety faults. In addition, Customers Division personnel are required to report all safety hazards as detected on Company premises, take every precaution and remain on site until the hazard rectification team arrives – all as required to prevent harm to passersby.

e) Labor Relations

The Company acts to maintain good labor relations at all organizational levels, communicate regularly with the labor organization and follow all of own employment agreements – all to prevent any breakdown in the labor relations. Labor relations breakdowns may be manifested by labor disputes which may lead to employee sanctions and even general and prolonged strikes which, in turn, may disrupt the supply of power to the Company customers. Such disruption may entail financial and safety damages to the state residents, affect their life quality, and also damage Company’s reputation and financial state (reduced incomes). In the event of a breakdown in labor relations, the Company continues to negotiate with the labor organization yet also takes actions against groups found to disrupt Company’s operations, including legal actions as required against the labor organization so as to prevent disproportional damage to the customer and to the Company profits. The Company also negotiates with the General Labor Federation (Histadrut) and the Government Authorities.

f) Human Errors

Human errors are inherent in any action, yet, in some instances, they may induce heavy damages and breaches, mostly in vital facilities and systems of the Company by system management supervisors, regional/area/power station command room supervisors or maintenance personnel. Many accidents originate from human errors. Therefore, to reduce the probability of error and the severity of the damage, the Company invests in personnel training and certification, writing of operating, maintenance and safety instructions, debriefing of incidents and implementation of lessons learned.

g) Knowledge Management and Retention

The Company’s operational success and ability to plan and pursue own development plans rely on its power to retain and attract skilled, qualified and suitable personnel as required for a complex enterprise such as the Company. The Company’s operational profile spans across a broad range of operations and skills, from engineering and design through operation and maintenance of power generation and transmission, to bookkeeping and other varied pursuits and services. Failure to attract and retain skillful and suitable personnel threatens the Company’s operational and managerial capabilities. This threat is mostly prominent when it comes to: − The requirement for engineers of specific expertise in the electricity domain, in view

of the aging generation of the Company’s veteran engineers. In this respect, the threat becomes greater still for lack of specialized electricity training programs in the Israeli engineering schools.

− The dropout of temporary employees leaves knowledge gaps and requires training of other personnel. To mitigate this risk, the Company promotes coaching programs for young engineers and their accompaniment by experienced ones, and also training programs designed to eliminate the knowledge gaps.



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3) Operational Risks (continued)

h) The Supply Chain

All purchases of equipment, services and works and all sales of equipment from Company stores are subject to laws, regulations and state agreements such as the Tenders Law and the GATT Agreement. Purchases are also subject to Company procedures, work instructions, quality requirements, such formal standards as ISO and other voluntary standards. The Company’s supply chain comprises purchasing processes, contract management, equipment supplies and storage of stocks. Risks are associated with a number of aspects, including: − Inadequate storage and preservation of equipment – equipment storage and

preservation other than under manufacturer’s instructions may result in equipment damage, sometimes to the point of a need for replacement with new equipment, which represents a direct financial damage. In addition, damage to equipment may also affect a project’s construction schedule.

Adequate storage and preservation are vital for contractual warrantee by the equipment suppliers.

− Supply of critical materials by single source suppliers – securing the availability of such critical materials as hydrogen, which are vital for power station operation, and mostly limited life and limited supply materials, will lead to non competitive prices. Moreover, the liquidation of a single source supplier of critical materials may lead to power station shutdowns.

To broaden its circle of manufacturers, suppliers and service providers, the Company encourages local production and certifies potential manufacturers and suppliers – all in full compliance with the international GATT agreement as related to the provision of equal opportunities to foreign suppliers. This pursuit contributes greatly to the involvement in the Country’s financial effort and to the attainment of reduced supply schedules.

i) Strategic Suppliers

The Company pursues contracts with strategic suppliers for the purchase of major equipment for combined cycle power stations as well as fuels as required for the power generation process. The major risk associated with this pursuit is that of a strategic equipment/fuel supplier going bankrupt. To minimize the effect of damage as may result from a strategic supplier’s liquidation, the Company effects various controls which include evaluation of suppliers in purchasing processes for financial strength, provision of guarantees, and contract management as required under Company procedures.

j) Generation (Reliability of Power Station, Substation and Switching Station Equipment)

The reliability of power station, substation and switching station equipment affects the reliability of the entire station. On any equipment failure, the station may suffer limited generation capacity and even removal from the generation and/or transmission line. Repair of large scale breakdowns entails extremely high direct and consequential costs as related to equipment, replacement parts, specialized labor, contractors and Company personnel, alternative fuel costs and additional costs as are due to transmission system losses.



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3) Operational Risks (continued) To preserve equipment reliability, periodic maintenance works and tests are pursued in evaluation of equipment status. Test results provide an indication of the need for equipment maintenance or replacement. The Company compares the failure data with data as collected by other electric companies worldwide, and has mostly found that own equipment reliability is often higher than the world accepted averages. Company’s All Risks insurance covers major equipment failures, although with a high deductible (10 million US Dollars as direct cost and 60 days for alternative fuels). Heavy equipment damages mostly entail time consuming insurance claims which often conclude in arbitration and/or settlement. Nevertheless, the Company managed to cover a considerable part of the insurance expenses in the past using payments made by the insurance company for “premature failure” claims in connection with power plant equipment. In recent years, Company’s fleet of generation units has increasingly relied on natural gas burning combined cycle stations. Although advantageous in numerous respects, the combined cycle stations feature higher and faster attrition as compared with the conventional units, all as a result of the higher operating temperatures and flow rates. The combined cycle units require frequent maintenance. They suffer a higher rate of major failures and their design life cycle is shorter.

k) Embezzlements and Frauds

Since the Company encompasses a broad spectrum of different business pursuits totaling billions of New Israeli Shekels yearly, it is exposed to a wide range of embezzlement and fraud hazards some of which may induce considerable financial losses. An embezzlement and fraud risks survey was conducted during 2009 to map the risks, the major hazards and the process controls required. This survey will serve the Internal Audit unit in its construction of a work plan. Company units have constructed detailed work plans based on recommendations as were provided under the survey above, with the progress of such plans reported to the General Manager.

l) Failure to Fulfill Development Plan

The development plan is designed to indicate the investments required within different time ranges in the development of power generation and supply systems to help attain two major goals: − Reliable supply of electrical energy with some system components in maintenance;

− System survivability and disruptive incident controls to be effected until such time when transition is made to a standard operating regime, with the development plan so selected as to ensure that the project will meet all of the constraints imposed under electricity, engineering, environmental and statutory laws.

The preferred alternatives are derived from techno-economical optimization and the prospects of alternative realization. Therefore, failure to meet development plan goals will compromise Company’s ability to attain the goals above in a cost effective manner. The main risk factors are due to the need for authorizations in the various projects and are associated with the power generation system, the uncertainty involved in the penetration of private electricity producers in the market, erroneous forecasts and faulty planning, delayed authorization by the various authorities and objections by regional or local boards to various aspects of the supply systems.



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3) Operational Risks (continued) The Company challenges these risks by promoting alternative projects, bridging projects and, recently, emergency projects to eliminate the gaps. It also employs system monitoring and automation to allow real time management. The cost of projects designed to minimize the probability of failure to meet development plan goals is significantly high.

4. Financial Risks a) Exposure to Changes in Exchange Rates on Foreign Currency for the Balance of

Loans

See detail under Market Risks in section 2 above. b) Exposure to Market Risks in Pension Fund Investments

See detail under Market Risks in section 2 above. c) Financing the Development Plan and the Ability of Raise Capital

Financing of the Company’s development plan as well as its outstanding debts cycle require, in Company’s estimation, external financing sources of extensive volumes. The Company estimates the financing level it will require in the future at some 3 to 4 billion New Israeli Shekels per annum, with some of the financing required for the longer term raised from loans by local and foreign banks and from local and overseas capital market bond issues. The Company’s power to raise long term financing in the future as well as the cost of such financing all depend on a variety of factors, including the Company’s business outcomes and financial status, the Company’s bond rating, the economical conditions and the capital market, the interest rates, the availability of credit by banks and other lenders, investors’ confidence in the Company, the Company’s business success, the security situation, legal and political conditions, the government’s privatization policy, and the ability to raise credit from banks and other financial institutions in Israel, which, in turn, is affected by the Single Lender, Lender Group and Single Issuer limitations. Financing of emergency plan phase A is estimated at approximately 3.6 billion New Israeli Shekels. The Electricity Authority has agreed to pre-finance 2 billion New Israeli Shekels through increasing of the electricity rate. Additional 185 million Euro for the importation of equipment under the emergency plan were financed by a loan from a bank consortium (DZ). The balance will be provided by the Company from own internal sources through reduction or postponement of other investments. How the second part (phase B) of the emergency plan will be financed is yet to be established. As for financing of an additional coal fired power station (Project D), on September 16, 2009, the Board of Directors considered the option of seeking an external investor in view of the heavy financial burden of this project, which is estimated at around 9 billion New Israeli Shekels. On September 22, 2009, the Board of Directors decided to approve the budget for continued Project D operations, and also, inter alia, to continue the effort to find a strategic/financial partner who will co-finance the project. Nevertheless, under the disposition made by the Company’s Board of Directors, the development budget for the year of 2010 was approved with the exception of freezing, of investments which included emergency project phase B, Project D, and the additional steam powered unit in Tsafit. Freezing was designed to avoid increasing of Company’s liabilities and to seek external financing sources. Nevertheless, it was decided to discuss the subject again during May 2010, to review potential financing solutions.



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4) Financial Risks (continued) Should the Company fail to raise capital as planned, then the pursuit of the development plan may suffer further delays and costs which may adversely affect Company’s operations, business outcomes and financial state.

d) Obligations to Lenders

Some of Company’s existing financing agreements and bonds include clauses which permit the lenders to request immediate payment on occurrence of an event which, in lenders’ view, may have a considerable adverse effect on Company’s ability to pay the debt, and on occurrence of events as related to the sale of certain assets. See more in Note 18 g to the Financial Statements. In this context, some financing agreements establish that the Company undertakes to submit to the lenders routine updates on all events as adversely affect or may affect Company’s operations and/or financial strength, however the right to request immediate payment rests, under certain circumstances, at the sole discretion of the lender. Should the lender decide to exercise own right to request immediate payment, this may entitle other lenders to demand immediate payment of the balance of the unpaid principal and the accrued interest and thereby compromise Company’s operations, business outcomes and financial state. In the event of immediate payment, the Company will be compelled to use funds from own internal sources or from external sources, with the latter dependent, inter alia, on the current state of the financial markets. On December 31st, 2009, these loans amounted to approximately NIS 29.6 billion.

e) Capital Structure

Company’s capital, recognized by the Electricity Authority as a basis for the capital costs to be recognized for the Company in the electricity rate, comprises a normative financial lever of one third equity capital and two thirds foreign capital. As perceived by the Electricity Authority, this composition is based on analysis of the financial data of the Company and some other electric companies operating in other economies. The foreign capital comprises a financing basket composed of the following elements: − Local currency (New Israeli Shekels) financing, reflecting loans raised in the local

market, recognized with a real Shekel interest and amounting to 50% of the recognized foreign capital;

− Hedged financing, reflecting loans raised overseas, recognized with a foreign currency interest and amounting to 36% of the recognized foreign capital;

− Local currency (New Israeli Shekels) financing at increased interest rates, reflecting foreign currency capital raising for which the Company is requested to make hedging transactions in protection against exposure to foreign currency and amounting to 14% of the recognized foreign currency.

In practice, the Company’s financial leverage comprises equity and foreign capital. Also, the composition of Company’s foreign capital does not correlate with the normative recognition of the electricity rate. The financial leverage represents a financial risk to the Company with regard to the norms it defined. Any further deterioration of this financial correlation may reduce Company’s credit rates and make it difficult for the Company to raise capital as required to finance its development plans.

f) Banks Risks

Company’s exposure the bank risks is mostly due to: 1. Company’s cash balances deposited in the local banking system (Bank Deposits); 2. Bank liabilities in connection with future transactions made vis-à-vis local banks

(Future Transactions);



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4) Financial Risks (continued) 3. Attainment of supplier guarantees, with the bank liable for payment in the event of

forfeiture (Attainment of Guarantees). Bank Deposits Company’s cash balances are deposited in short term accounts within the local banking system. Since deposits in Israel are not insured (the Bank of Israel has not provided a written guarantee to cover the payment of funds deposited in the banks on liquidation of any specific bank), the Company is exposed to the various banks. For maximum dispersion of the banks exposure, the Company has set up a depositing procedure run on a daily basis, which relies on the financial strength of the banks. Under this procedure, the banks were classified into various rating categories based on external data (Maalot and Midrug) and/or on their own financial statement data. The procedure establishes the minimum number of banks where deposits are required to be made, the maximum sum for deposit and also the ratio of the sums deposited in the various banks, all subject to the sum deposited and to the rating category established for each specific bank. Future Transactions The Company makes future transactions both to meet own financial obligations to external organizations and to fence its exposure to changes in the currency exchange and/or interest rate. Future transactions are made for various time ranges using various instruments such as forward transactions and swap transactions. In this context, the sum exposed to the banks is the net capitalized sum of all future settlements under the transaction. To neutralize such exposure, an MTM mechanism is available in some swap transactions which eliminates Company’s exposure to the bank and vice versa at any interest payment point. Attainment of Guarantees The Company receives from its suppliers performance guarantees and advanced payments through local or overseas banks. The obligation to transfer the funds to the Company (in the event of forfeiture) lies with the bank issuing the guarantee (Issuing Bank). To neutralize the exposure to overseas banks, the Company requires that the minimum international rating of the bank be A. The rating of the issuing bank is checked on attainment of every guarantee. All of the banks in the country where guarantees are received from are of the minimum required rating.

g) Doubtful/Bad Debts

In all matters of collection enforcement, the Company follows Marketing Division procedures using Red Lights information as obtained from business data banks (e.g. BDI or D&B) regularly by the regional and area collection departments. The Company acts to reduce outstanding debts by customers reported as financially challenged. To this end, it issues invoices for reduced charging periods, makes certain that the outstanding bills are paid and accepts no post dated checks. Also, as an alternative to disconnection, use is made of prepaid meters.

h) Class Actions

As of this date, seven applications are outstanding against the Company for claims to be recognized as class actions amounting to approximately NIS 21 billion, detailed in Note 24 to the Financial Statements.

Based on the opinion of its own legal advisors, the Company has not made any provisions in its financial statements for these actions.



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4) Financial Risks (continued)

i) Rate Determined Does Not Cover Company Costs

The Company’s financial state is affected, inter alia, by the level of electricity rates it charges its consumers, as established by the Electricity Authority by force of the Electricity Sector Law - 1996 and therefore, the Electricity Authority has the sole authority to establish and are therefore beyond the Company’s control although how they are established affects directly and considerably Company’s income, cash flow, profitability and financial strength (see Notes 1 c and 3 to the Financial Statements). The Electricity Sector Law establishes that the Electricity Authority should set the rates based on the cost concept, considering also the type and level of the services provided, and also considering an adequate rate of return on the capital, where the Electricity Authority permitted to exclude, in its setting of the rates, all or partial consideration of such expenses which it feels unnecessary in Company’s pursuit of own obligations as a vital service provider. The rate should reflect the cost of the specific service, with the price of no specific service reduced at the rate of increase to another service price. The rate will be revised by a formula as was established by the Electricity Authority, where the revised formula may include parameters of efficiency (meaning, the rate at which the revision may be reduced, as established by the Electricity Authority in consultation with the ministers, to promote the efficiency of organizations holding vital service provider licenses). On February 12, 2004, the Supreme Court decreed, inter alia, in Company’s petition against the Electricity Authority, that the consideration with regard to preserving Company’s financial strength, however relevant to the setting of the electricity rate, reflects but one facet of the public interest entrusted to the Electricity Authority under the Electricity Sector Law. When exercising its legal authority, the Electricity Authority should also consider the full complex of factors which are designed to “regulate electricity economy operations for the good of the public while securing availability, quality and efficiency and all while providing the grounds for competition and minimization of the costs”. Based on the above, Company’s exposure to risks may be characterized as mostly due to expenses which are not or will not be recognized for rate purposes, and from formula revision mechanisms which do not cover Company’s full exposure to price changes, unbudgeted expenses and costs due to the efficiency requirements where and to the extent to which the Company fails to comply with such requirements. Another important reason why the electricity rate is a risk factor is that recognition of Company’s cost of investments is established based partly on past records and partly on various normative parameters with no guarantee that all of its future costs will be covered. Another risk factor originates in that there is still no sufficient information on the concepts guiding the establishment of the rate base in the next evaluation period for the full electricity chain (the current rate base for all segments was due to expire in 2005). Yet to be established are also new rate bases for the generation, transmission, transforming and distribution segments and for consumer costs. The new rate base for the generation segment was determined in February 2010. Initial analysis of the rate indicates that it does not provide full coverage to capital costs of the Company, due to the expected non-recognition of part of the costs of Company assets. Moreover, the rate may not cover the expected operational costs in the generation segment in the coming years. The Company is still studying the full significance of the rate and will then address a request to the Electricity Authority to amend the rate so as to enable the Company to perform its normal operation while achieving an appropriate yield.



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4) Financial Risks (continued) Long term planning (an essential tool in the current electricity economy) requires information on future electricity rates. Such information is also vital for Company’s decision making with regard to projects and long term plans. In its financial statements, the Company follows international standards as required under the Government Companies regulations, complete with all exclusions as provided therein for the Company. These regulations will remain in effect until the end of 2009. Should they not be extended, the Company will suffer exposure as will be due to the difference between the rate coverage as calculated by index adjusted data and the representation in the financial statements under international standard requirements (nominal data). Since the Company’s costs will not be covered by the rate, losses may be created in its financial statements. As for several of the Electricity Authorities previous decisions as related to the rates, the Company is still pursuing intensive negotiations with the Electricity Authority in this matter, including such decisions as related to costs for which it requested rate coverage and to future application of the IFRS (see Note 3 to the Financial Statements). Should these negotiations conclude with Company’s position on this matter still overlooked, they may adversely affect Company’s operations, business outcomes or financial state.

j) Financial Statements and Internal Audit Risks

1. The Company faces a risk as due to failure to meet the deadline specified under the Law and under various agreements for the publication of its financial statements and also as due to the potential need to restate previously published financial statements.

This risk originates mostly in the posing of heavy accounting issues for the first time both by the external auditor during the financial statement review and audit and by changes to the accounting, legal and other environments soon before the date when the statements were to be published. This may make it objectively difficult to establish an accounting policy which will also be acceptable to the auditing accountant, and to implement it in the financial statements within the legally required schedule. If realized, this risk may have extensive implications, from the imposition of penalties and consideration of position holders as personally liable, to impact on the business environment within which the Company operates, including its capital raising capability, increased capital raising cost and potential adverse effect on Company’s business operations.

2. The Company also faces a risk as associated with the correctness and inadequate disclosure of the information presented in its financial statements as may arise from lack of an effective internal audit system to handle the reports and disclosures provided in these statements.

For Company’s preparation for the evaluation of its internal audit effectiveness and disclosure controls as applied to the reports and disclosures provided in its financial statements, see Section 6.b) of the Board of Directors’ Report.



86

6. Miscellaneous (continued) g. Environmental Concerns

See Note 1.H to the Financial Statements. h. Organizational Structure

For a description of the organizational structure, the number of employees by field of activity in accordance with the organizational structure – see the Report of the Description of the Corporation’s Affairs as of December 31, 2009, Sections 2.1.9, 2.2.8, 2.3.9

i. Dividend distributions

See the Statement of Changes in Shareholders’ Equity. j Taxation

See Note 22 to the Financial Statements.

k. Legal Procedures See Note 24 to the Financial Statements.

l. Assets – Land and Appendages

See Note 11 to Financial Statements. m. Agreements

See Note 24 to Financial Statements.

The Board of Directors and Management wish to express their appreciation to the Company’s employees and its managers.

Amos Lasker CEO

Date of Approval: March 31, 2010

Dr. Ziv Reich External Director

3

The Israel Electric Corporation Ltd.

Supplement

Additional report regarding the efficiency of the internal controls on the financial reporting


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SECONDADDENDUM

(REGULATION 2)

A REPORT OF THE BOARD OF DIRECTORS AND THE MANAGEME NT ON THE INTERNAL AUDIT OF THE FINANCIAL REPORT IN ACCORDANC E WITH

GOVERNMENT COMPANIES REGULATIONS (ADDITIONAL REPORT REGARDING THE EFFICIENCY OF THE INTERNAL

AUDIT OF THE FINANCIAL REPORT), 2007

The Management, under supervision and upon approval of the Board of Directors of the Israel Electric Corporation Ltd., is responsible for establishing and maintaining an appropriate internal audit of the financial report of the Company. An internal audit of the financial report is a process intended to provide a reasonable measure of assurance about the reliability of the financial report and the preparation of the financial statements for external purposes, according to accepted accounting rules and the directives of the Government Companies Law. Due to its built-in limitations, the internal audit of a financial report is not intended to provide an absolute assurance that an erroneous presentation will be prevented of discovered.

The Management and the Board of Directors conducted an inspection and evaluation of the internal audit of the financial reporting of the Company and its efficiency, based on criteria defined in a control model named "COSO Model".

Based on this evaluation, the Company's Board of Directors and Management concluded that the internal audit of the financial report of the Company for the period ended on December 31, 2009, is not effective, due to a material weakness of the internal audit of the financial reporting, as detailed below.

The Company's control of the financial value of assets managed in the pension fund of Company employees is insufficient. Correction of the material weakness The Company intends to engage an expert in this field with the purpose of receiving an evaluation of funds assets value, in accordance with IFRS standards. The Company also intends to assimilate a dedicated system for calculating and managing the assets of the fund.

The Company believes that these corrective acts will correct the material weakness in the aforementioned internal audit of financial reporting.

The Opinion of the External Auditor The external auditor of the Company, Brightman Almagor Zohar & Co., who audited the financial statements of the Company for the period ended on December 31, 2009, issued an opinion on the effectiveness of the Company's internal audit of the financial reporting, as follows:

The Company's control of the reasonableness of the assumptions that serve as the basis of the actuarial liability is insufficient. The Company's control of the rights validity of salaries paid to Company employees is insufficient. The Company's Management believes that it is maintaining an effective internal audit process, including sufficient control required to prevent the risk of creating a material weakness in this subjects.

Mr. Harel Zeev Blinde Senior Vice-President of Finances and Economics

Mr. Amos Lasker Chief Executive Officer

Mr. Michael Lazer Chairman, Finance

Committee

Dr. Ziv Reich External Director

March 31, 2010

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