The world has watched in awed amazement as an unprecedented wave of popular political protest has swept North Africa and the Middle East during recent months. For Israel, situated at the heart of the region stretching from the Atlantic Ocean to the Persian Gulf, the potential implications of these developments go far beyond the price of oil. The emergence of a new crop of governments in many Arab countries and of a new generation of politically involved young people carries the potential for massive changes in the attitude toward Israel of these countries and their leaders — changes that could be fraught with danger, or laden with opportunity.

This is especially true of Egypt, the largest and most populous of the Arab countries, and traditionally the political leader of the Arab world. Although separated from Israel by the barren and largely unpopulated Sinai Peninsula, Egypt was the lynch pin of the efforts by the Arab countries to eliminate the nascent Jewish state in the 25 years following its creation in May 1948. Israel inflicted heavy defeats on the Egyptian and other Arab armies in 1948, 1956 and, most notably, in the Six-Day War of June 1967, but the resultant Israeli complacency was shattered barely six years later, when Egypt and Syria launched a carefully coordinated assault. While the initial Egyptian military successes were reversed over several weeks of intense fighting, they enabled the country and its armed forces to regain their pride and self-confidence.

The Yom Kippur War of October 1973 changed the strategic perceptions of both Israel and Egypt and triggered a process that moved the relationship between the two countries from one of ongoing confrontation and periodic outbreaks of fighting, to one of co-existence and, in some key areas, co-operation. A series of interim agreements in the mid-1970s saw Israel cede its control of western Sinai — including the oilfields it had discovered there — allowing Egypt to re-open the Suez Canal and paving the way to the full peace treaty concluded between the two countries in March 1979. This marked a watershed event in Israeli and, indeed, Middle Eastern history. For the first time an Arab country — indeed, the most important one — granted formal recognition to Israel and ended all aspects of the state of war between them. Both sides paid a stiff price: Israel withdrew fully from Sinai by 1982 while Egypt suffered a period of political and diplomatic isolation within the Arab world. But both countries judged the long-term strategic benefits accruing from the treaty as more than justifying its costs.

Common Geo-political Interests

Since then, the Israeli-Egyptian relationship has remained solid, but limited in scope. It has weathered numerous ups-and-downs, often linked to positive or negative developments between Israel and the Palestinians. Over time, the ties between the two countries’ political leadership and, critically, between the senior echelons in their military and intelligence services have become robust enough to handle periods of tension and areas of disagreement. These ties are rooted in shared interests at the bilateral and regional level.

One such area of common ground is opposition to radical Islamist groups. In the Israeli case, Hamas is the largest such group in the Palestinian political arena and its extremist ideology makes the movement a sworn enemy of Israel. However, Hamas is an offshoot of the Muslim Brotherhood which, despite having been banned by successive Egyptian governments, remains the largest Islamist movement in Egypt. In the 2006 elections in the Palestinian Authority, the U.S. insisted that Hamas be allowed to participate — despite the objections of both Israel and Egypt. Hamas won a majority in the Gaza Strip and cemented its control there the following year by ejecting its main political opponent, the Palestine Liberation Organization (PLO). Since then, Israel and Egypt have tacitly co-operated in blockading the Gaza Strip, in an effort to neutralize Hamas.

At the regional level, too, there are clear common interests. Israel has long viewed Iran as the primary threat facing it while Egypt, although not directly threatened by Iran, is nonetheless a part of the wider anti-Iranian camp, which includes Saudi Arabia and most of the other Gulf States. These countries, despite being formally hostile to Israel, are in practice allied with it against Iran, and they also look to Egypt for leadership and support.

At the global level, the Israel-Egypt peace treaty, along with other aspects of the relationship between the two countries, are underwritten and supported by the United States. Both countries are recipients of significant American military aid and their armed forces have established close links with the U.S. military establishment.  

Weak Business Links

However, beyond the governmental and military spheres, the shallow and narrow nature of Israeli-Egyptian relations is apparent. This is true in many areas — including sports and culture, where almost no links have been forged — but in trade and business it is easy to measure how much, or little, progress has been made.

Dan Catarivas, head of the international department of the Israel Manufacturers Association, notes, “Bilateral trade relations with Egypt are very narrow.” Catarivas knows not just the numbers, but also what lies behind them. In his previous role, as head of the international division of the Ministry of Finance, he played a leading part in Israeli efforts to expand trade ties with Egypt. Catarivas says that Israeli exports to Egypt, which amounted to a mere $147 million in 2010, represent the precise amount of Israeli content required in Egyptian exports to the U.S. under the terms of a trade agreement between the U.S., Egypt and Israel.

This agreement allows for the establishment of free trade zones — known as Qualifying Industrial Zones (QIZ) — in which manufacturing operations are conducted, the output of which is granted access to the U.S. market free of tariffs and quotas. The QIZ with Egypt is based on a similar arrangement with Jordan authorized by the U.S. Congress in 1997, which awarded to goods manufactured in a QIZ the same status as Israeli goods under the terms of the U.S.-Israel Free Trade Agreement (FTA). The goal of the QIZ with Egypt is to promote Israel-Egypt co-ventures and spur the creation of jobs and industrial production in Egypt.

Jordan’s QIZ agreement was a milestone on the way to a full FTA with the U.S. This encouraged the Egyptians to go down the same route and they signed their QIZ agreement in 2006, which granted tariff- and quota-free access to Egyptian goods, on condition that they contain at least 10.5% Israeli content. In order to meet this demand, Egypt gradually increased its imports from Israel of threads, chemicals, software and other goods and services used by the Egyptian textile industry, which was the main beneficiary of the QIZ.

However, the Egyptians imported no more than the minimum required, and Catarivas notes that this attitude was a key factor in the U.S. refusal to upgrade the QIZ to a full FTA, as had been done for Jordan. “We were constantly seeking ways to expand trade beyond the QIZ requirements,” recalls Catarivas. “The real aim of the QIZ was for it to serve as a springboard for other areas of business co-operation. But the Egyptians were not interested, so nothing came of these efforts.”

Natural Gas Exports

In contrast to Israeli exports to Egypt, Egyptian exports to Israel have grown and amounted to some $355 million in 2010. But these exports are concentrated almost entirely in one item — natural gas, which is supplied by a company called EMG (East Mediterranean Gas) via a pipeline across the Sinai peninsula. EMG was founded as a partnership between Hussein Salem — an Egyptian businessman and long-time confidant of ex-President Hosni Mubarak — and the Israeli Merhav Group, owned by Yossi Maimon, with the Egyptian government-owned EGAS holding a 10% stake. Salem diluted his 65% stake down to 28% during 2008 by selling 25% of the company to PTT, Thailand’s national oil company, and another 12% to American businessmen, while Merhav’s stake declined from 25% to 20.6%. Salem reportedly fled Egypt in late January or early February, as the Mubarak regime crumbled. Rumors that he was arrested in Dubai, carrying $500 million in cash, failed to be proven. On March 10, Cairo’s criminal court confirmed an order freezing Salem’s personal and family assets. 

What is certain is that in 2008, EMG signed a 20-year contract to supply natural gas to Israel, thereby becoming the largest single source of this fuel for the Israeli economy. EMG’s main customer is the state-owned Israel Electric Corp., which is in the process of converting its electricity generators from dirty sources, such as coal and diesel, to natural gas, which is both cheaper and cleaner. At the beginning of 2011, 40% of IEC generation was powered by natural gas, of which Egypt supplied some 35%, or 15% of total production.

An interesting insight into the way the general public in Egypt and Israel view their countries’ relationship is that any reading of the respective popular media, and especially the blogosphere, reveals that the Israelis are convinced that they are being massively overcharged by the Egyptians. In contrast, the Egyptians are equally convinced that their gas is virtually being given away. Indeed, in early March a spate of reports in Egyptian and Gulf-based media claimed that EMG had paid Mubarak’s sons hundreds of millions of dollars in kickbacks in return for being allowed to sell the gas cheaply to Israel.

Whether these accusations have any factual basis remains to be seen, but even in the supposedly staid world of known facts, there is plenty of drama.  On February 5, an explosion at a measuring station in northern Sinai along the pipeline supplying gas to Jordan and Syria led to the closure of a separate pipeline feeding gas to Israel. The Egyptian authorities attributed the explosion to an accident, but in Israel it has been viewed as a terrorist attack, the real target of which was the pipeline to Israel — which is better protected, being encased in concrete and buried underground. In the month following this incident the Egyptian authorities repeatedly announced the imminent resumption of gas supply, but each time the outcome was a further delay. According to a Reuters report issued from Jerusalem on March 16, the supply has now resumed. But while the disruption dragged on, it fueled the suspicion in Israel that it stemmed not from technical or operational problems but from a change of policy on the part of the new Egyptian government.

“[The supply of gas] serves as a litmus test for the attitude of the Egyptian regime,” notes Gil Bufman, chief economist of Bank Leumi, Israel’s largest bank. By the same token, he adds, the emergence of a problem relating to Egyptian supply “serves as proof that we need to diversify by having several providers. Israel’s offshore fields could themselves be viewed as multiple sources, as well as providing a solution to the problem of storage of excess supply — depleted fields can be ‘refilled’ with gas from other fields and used as ‘storage depots.'” Overall, Bufman says that the disruption in supply stemming from the pipeline incident — whatever its true cause — can and should “act as a catalyst for us to move faster in bringing the new fields into production.”

This sentiment is echoed by Uriel Linn, the president of the Federation of Chambers of Commerce. “There is a growing feeling that the gas supply issue is a kind of general warning regarding our exposure to supply disruptions, whatever their cause. This will lead to an all-out effort to speed-up the development of our own energy sources.” However, beyond the specific issue of gas, Linn stresses that “we are not at all dependent on Arab countries for trade. Indeed, our main trade with the Arab world is that conducted with the Palestinian Authority, whereas we have no substantive trade with Arab countries.”

Trade in Services

Nevertheless, there are other economic ties between Israel and Egypt beyond the limited volume of trade in goods. Trade in services is often termed ‘invisibles’ — and with good reason. There are several interactions between Israel and Egypt in services, but the impact of any disruption in these need not always be negative.

Some 20% of total Israeli trade in goods passes through the Suez Canal, so clearly anything that interfered with the Canal’s operations — whether specifically directed at Israel or a more general event — would cause problems, the least of which would be higher costs but which could have a much more profound impact if it involved a breach of the Israel-Egypt peace treaty. On the other hand, Catarivas points out that Egypt’s Mediterranean ports — Alexandria, Damietta and Port Said — have developed into regional trans-shipment ports where large ships unload containers that are then sent on smaller ships to Israel and other countries in the eastern Mediterranean. “Any prolonged upheaval in Egypt will disrupt these trade flows — but there are alternatives,” he says. “The Egyptian ports would lose this business, but that would be to the benefit of ports in Turkey, Israel or elsewhere.”

Tourism is another quintessential service sector — and a critical one for Egypt, where it accounts for 11% to 12% of both GDP and employment. Here, the impact of a crisis is more complex. Experience shows that even a specific incident in one country, such as a terrorist attack, has a knock-on effect on its neighbors — so a general regional upheaval, such as the one currently underway, may be expected to hurt Israel, too, even if it is not involved. Furthermore, in recent years there has developed a useful niche in the Israeli tourism sector: Russian tourists staying at resorts in Egyptian Sinai take one- or two-day trips into Israel and the Palestinian Autonomy, visiting Jerusalem, Bethlehem and Galilee. But against this loss is the prospect of at least partially compensating gains: Some of the tourists who would have gone to Sinai will instead choose Israel’s Red Sea resort town of Eilat, or Jordan’s Aqaba.

What Exporters Think 

Despite the fallout from the events in Egypt and the wider Arab world on various sectors of the Israeli economy, few Israeli businessmen are losing sleep over them. According to Dafna Aviram-Nitsan, head of the Economic Research Department at the Manufacturers’ Association, who maintains close contact with corporate executives from a wide range of industries, this does not reflect apathy but rather the fact that Israeli companies have more immediately pressing concerns.

“From the point of view of most manufacturers, and businessmen generally, the events in Egypt are country-specific,” she explains. “The working assumption is that calm will be restored and that the situation there will stabilize as a new government takes over.” At the other extreme are the events in Libya, which have caused oil prices to shoot up — but that is a global phenomenon that no country or company can escape.

Meanwhile, the challenges that Israeli businessmen have been facing for years have not gone away. “The people I speak to are focused on the ongoing rise in commodity prices — which long predates the political upheavals. They also have to contend with the revaluation of the Israeli shekel, which has been pushing higher against the dollar and euro for several years. More recently, domestic interest rates have been rising, raising their borrowing costs. On top of these is the growing pressure to raise wages. All of these factors combine to erode margins — so that even if a company is still seeing good global demand for its products, its profitability is increasingly under pressure.”

Thus, the view from the boardroom is that the political drama being played out in North Africa is more of a news event than something that directly impacts management decision on a day-to-day basis — so far at least.

Similar sentiments can be heard in the Israeli financial sector, especially in trading rooms. The revolution in Egypt caused the risk premium on Israeli bonds, measured in the CDS market, to jump sharply at first — but it soon settled down again, albeit at a higher level than before the region became a hot topic. As for the Israeli currency and equity markets, one would be hard put to be able to discern a specific “Egyptian influence” on the trading patterns of January and February, beyond news-driven falls on a few days. Indeed, the main share index, the Tel Aviv 25, posted an all-time high in January — exceeding its previous record from 2007 — and almost touched that level again in late February, when the revolution in Egypt seemed to have run its course.

Geo-strategic Scenarios  

Perhaps it is understandable that businessmen tend, as Dafna Aviram noted, to take a detached view of political developments in countries in which they don’t do business. But an attitude that views the fall of the Mubarak regime in Egypt, and of other long-established autocracies and dictatorships in other Arab countries, as just another item on the news may be overly sanguine and even short-sighted from an Israeli perspective. Certainly it is not one with which the Israeli intelligence community or its peers in the U.S. and elsewhere — all of whom failed to foresee the extent of the upheaval, even once it was underway — would agree.

Although Israeli government officials, especially ministers, have been careful to avoid commenting publicly on the events in Egypt and their possible implications, there is little doubt that they are seriously concerned. Indeed, the unusual self-restraint being shown on the subject by Israel’s usually-garrulous leaders is itself the most powerful statement possible. It reflects the sense that, however tough Mubarak and his allies were toward Israel over many issues, their underlying commitment to the Israel-Egypt peace treaty was unwavering — but this may not be the case for the government that succeeds them.

That explains why the Israeli political and military establishment, irrespective of party affiliation and government/opposition status, sought to persuade the Obama administration not to openly line up against Mubarak. This effort failed and, if anything, damaged Israel’s already-frayed relations with the Obama administration. It also will have done little to endear Israel to the liberal opposition groups in Egypt, while the Muslim Brotherhood and other Islamist groups are in any event firmly anti-Israel. That leaves Israel hoping that the Egyptian army will continue to hold direct power in Egypt or, at the least, exert veto power over any civilian government in key areas of foreign and defense policy.

But the wave of revolt sweeping the Arab world has opened a Pandora’s box. New concepts previously unimaginable in Middle Eastern and Maghreb countries, such as public opinion shaping policy, have been unleashed. How these will play out is unknowable, especially over the medium and long term. The most optimistic scenario is that Egypt will move in the direction of democracy so that it will be possible, over time, to establish a ‘peace between peoples’, rather than the peace between governments that has been in place for more than 30 years. But there is also the possibility, however unpalatable to contemplate, that the Egyptian public may choose an unfriendly stance, or even an overtly hostile one.

This year’s Herzliya Conference, a prestigious quasi-academic event that brings together leading Israeli and international experts in the fields of geo-politics, intelligence and counter-terrorism, was held in early February, under the shadow of the unfolding events in Egypt. One of the Israeli speakers prepared to explore the potential negative scenarios was Pinchas Buchris, a former director-general of the Defense Ministry. He noted that the Egyptian army is, by size, the 11th or 12th largest in the world, and that it is equipped with the best American technology. Its potential as a threat to Israel is therefore apparent — but that threat is still remote and requires momentous decisions by a future Egyptian government, which will not be taken either lightly or quickly.

“In a theoretical scenario, if Egypt should decide to revoke the peace treaty, Israel will have time to prepare for that,” Buchris said. However, he added that if a change of strategy by Egypt were to occur, it would require major changes in Israel’s defense posture and, by extension, in the defense budget. The implication, unspoken by Buchris but well understood by Israeli policymakers, is that not only the country’s defense and foreign policy are at stake, but also the underpinnings of its economic and social policies. That is how fundamental the peace treaty with Egypt is to Israel.

This theme has not been part of the public debate in Israel, at least to date — but foreign analysts have homed into it. George Friedman, founder and CEO of Stratfor, an American strategic analysis and research company, opened a note to his clients in February by stating, “The events in Egypt have sent shock waves through Israel”, and then devoting the rest of the analysis to explaining why. His conclusion, like Buchris’s, was that events to date have not been a game-changer — but they serve as a warning of the potential for the game to change.

Yet even the “game-changer” concept is a flexible one. Egypt may yet choose to turn away from the strategy of co-existence and limited co-operation with Israel, with all the negative consequences that would entail from an Israeli point of view. But the regional unrest is still gathering strength and it has many potential victims. Regime change could come to Iran, too — an equally dramatic development, but one with immense positive connotations for Israel.  

If one clear lesson can be extracted from the events of the opening months of 2011, it is that the Middle East is entering a new era, politically, socially and probably economically. After decades of stability that centered on opposition to change, that is a wrench — even for bystanders, let alone for the people directly involved. Israel is more than a bystander, yet not directly involved. In this position, it must wait to see whether the new era will shape up as one of opportunity as the region moves forward, or of threat as old traumas re-emerge.