Tuesday, May 01, 2007

Iran's Sanctioned Oil and Gas Industry

Iranian oil and gas resources are too important to be ignored

Even though it is the foremost traded commodity in the world, oil is not like any other commodity. It is also a geo-strategic and political commodity.

Astonishing economic growth, especially in developing countries over the past few years has fueled big increases in oil demand. Today the world consumes 85 million barrels of oil per day. This is equivalent to about 156,000 liters per second. By 2030, global oil demand is expected to increase to 220,000 liters per second.

Since oil is unlikely to be abundant in the future and the era of easy and low-cost oil is coming to an end, to meet that demand countries and companies have started to look around in the world where there is still hope. Hence an oil resource competition has started and security of supply became a major issue.

As of January 2007 Iran had 136 billion barrels of oil, second largest in the world, waiting to be extracted. On top of that, Iran has a strategic location in Middle East and is close to all important oil fields there. It is possible that Iran might block the Strait of Hormuz (at its narrowest point it is 55 km across), where one third of world’s oil exports pass by every day, and cause an oil crisis, never seen before.

This is a big worry in international community. Ahmedinejad will not make the first move. Because he knows pretty well the US policy engraved in Carter Doctrine of 23 January 1980, which implied the use of military force when necessary to continue the flow of oil from the Middle East. For whatever reason if oil flow is disrupted through the Straits, Russia will be a big beneficiary.

But Iranian oil industry is not in good health

Even though Iran has huge reserves, a multitude of factors (ranging from lack of investment in the maintenance of fields and infrastructure, lack of rebuilding the installations destroyed during the war with Iraq, difficulty in attracting foreign companies, American and European sanctions, and bad management) prevented the production achieve its desired levels.

Today Iran produces over 4 million barrels per day (mb/d). This might sound a lot but bad news are in order. First, Iranian oil field decline rates, according to oil minister, are around 0.5 mb/d. Second, Iranian oil consumption has been soaring, causing a substantial drop in oil exports. According to official figures oil exports are declined to 2.3 mb/d in 2006. Third, Iran currently imports about 40% of petroleum products need.

These have been interpreted by some people in such a way that they claimed of Iran becoming a net oil importer in 10 to 15 years time. For instance, in a much publicized December 2006 report by the National Academy of Sciences of the U.S. it is argued that if the current increase in local Iranian oil consumption continues and the current decline in oil production is not stopped, then by 2015 Iran's oil export will decline to zero.

Instead of being alarmist, one should look at the options. Iran has three options: a) increase production, b) put a brake on its consumption, c) increase refinery capacities.

As far as production is concerned, it is widely agreed that to compensate the decrease in the fields plus new capacity addition would be impossible unless radical shift in the legal and fiscal model, including buy-back agreements, take place. Even though the government would like to maintain its capability of producing oil, gas re-injection into oil fields has become more and more pronounced. It is true that the souring relations with western powers have severely hampered progress in oil industry but it is quite naïve to think Iranians watch their oil fields dry and do nothing.

On the contrary, Iran plans to increase oil production to 5 Mb/d by 2009 and 7 Mb/d by 2024 would be nothing more than nonsense. Giant Azadegan and Yadavaran fields, and substantial increase in condensate production coming from gas fields surely will help in achieving that target.

As for domestic consumption some radical move is necessary. The first thing the Iranian government will consider is to reduce domestic subsidies which are told to be currently over $20 billion. According to the Iranian News Agency, Iran’s parliament has already approved in March the rationing of subsidized oil. Starting from May 22 this year Iranians will pay 11 US cents (1000 rials) instead of current 9 US cents (80 rials). This move may hurt the popularity of Ahmedinejad who mobilized the poor voters with “I am one of you and I know you well.” But he doesn’t have much option.

On the refinery side, Iran has already begun upgrading the existing refineries and building new ones. Current refining capacity of Iran stays at 1.32 mb/d. The plan is to increase it to 2 mb/d by 2011 through completion of projects currently on development in existing refineries and to 2.5 mb/d by 2016 buy building new ones.

Natural gas industry is in no better situation

What makes Iran important is not only its oil resources but also its abundant gas, second largest gas reserves in the world. Natural gas accounts for almost half of the country’s total energy demand. Today, in order to satisfy domestic gas demand practically all the present production is sent to domestic market and some extra gas is imported from Turkmenistan.

However, the government intends to increase domestic use of gas to its highest possible levels due to (a) maintain the correct pressure in its ageing oil fields which requires huge volumes of gas for re-injection, (b) substitute gas for oil products on the domestic market especially for power generation, (c) utilize it in Iran’s mega petrochemical industry, (d) increase the use of compressed natural gas in transport.

That is why Iran’s policy has recently focused on exploration and development of gas projects and reducing gas flaring. Through these efforts domestic demand is expected to be fed sufficiently and excess production is planned to be exported by pipelines and LNG in order to generate income.

These can be achieved if development of South Pars gas projects and related infrastructure (such as four LNG plants currently on table) are speeded up. Unless financing and investment problems are solved, Iran will stay much behind of Qatar. Any further delays mean loss of gas and income.

American financial attack on Iranian Economy is intensifying

Since the 1979 revolution Iran has been under constant US unilateral sanctions. The first U.S. sanctions against Iran came in November of 1979, after the hostage crisis. The import of Iranian goods into the U.S. had been banned by 1987. In 1995, President Clinton issued an Executive Order banning U.S. investment in Iran's energy sector.

Under the US Iran-Libya Sanctions Act of 1996, which imposed mandatory and discretionary sanctions on companies investing more than $20 million annually in Iranian energy sector, the US and non-US companies were discouraged doing business in Iran. When Kaddafi opened up upstream oil and gas industry (and gave up weapons program) Libya was dropped and the Act was called the Iran Sanctions Act (ISA). With the help of the “Iran Freedom Support Act” ISA now extends until the end of December 2011.

Subsidiaries of U.S. firms are not barred from that but some U.S. companies have come under scrutiny for dealings by their subsidiaries with Iran (read Halliburton’s gas deal in South Pars Phases 9 and 10). Even though no projects have actually been sanctioned yet under the Act, they are used as a threatening tool to shy away from financing energy projects in Iran.

Recently U.S. pressures through sanctions have intensified under the guise of stopping Iran from its nuclear ambitions. The desired effect, however, could not be achieved due to high oil prices which helped Iran. The U.S. then tried to reduce oil prices with the help of Saudi Arabia and (according to some) of funds, but with only very short lived success. When that didn’t work out, the U.S. changed its strategy and has began putting considerable pressure not only on governments and energy companies but also on international banks and financial institutions to cut their ties with Iran. The aim is to let the Iranian energy industry starve.

In his testimony before the U.S. before the Senate Foreign Relations Committee in March 2007, Nicholas Burn, Under Secretary of State for Political Affairs made it precise: “ISA has been extremely valuable in emphasizing to foreign governments and firms our concerns about Iran and highlighting the risks and potential consequences of investing there…we believe that ILSA/ISA has been a factor in Iran’s lack of recent success in attracting the oil and gas investment it seeks.”

It is true that foreign sources of finance are drying up, the country is facing problems in financing industrial projects and is unable to attract sufficient foreign investments. Western and Japanese banks recently cut their financing for Iran. Several arrangements for developing Iranian oil fields turned out to be a blow due to political pressures. Lately, Japan’s Inpex has given up its leading role in the development of the giant Azadegan oil field. Total has announced in April 2007 that it may delay or possibly cancel its South Pars LNG project because of rampant cost inflation and “geopolitical concerns.”

What might come in the very near future is an international ban promoted by the UN Security Council on purchases of Iranian goods and a ban on international investment in Iran’s energy sector.

More importantly a possible ban on refined oil products (such as gasoline and diesel) or other products export to Iran would hurt Iranian economy immensely. If takes place, it will cut the hands of Iranian economy and will eventually hurt the poor, whom Ahmedinejad promised to improve their lives.

Furthermore, the US government may push Turkey not to get additional gas from Iran. This might have significant implications for the Nabucco gas pipeline project (which was planned to carry Caspian gas from Turkey to Bulgaria Romania, Hungary and Austria).

In the mean time, a big hope for Iran is to finally conclude more than a decade long discussions on proposed Iran-Pakistan-India gas pipeline. But as usual the U.S. may jump in any time providing carrots to India and/or Pakistan to give up the deal and instead look for supplies from Qatar. In a similar situation, for example, the U.S. has pressured Georgia not to get any long term energy deals with Iran, but had to close its eyes to have short term gas deals in winter months in exchange for supplying electricity to Iran.

Last but not least, as the Iranian Economy Minister, Davoud Danesh-Jafari, said in January 2006: "sanctions against Iran would probably have the effect of driving up oil prices to beyond levels that western countries can imagine." Maybe this is what the U.S. and its allies want too, I mean keep the oil prices high.

In the next post I will discuss Iran's solutions and contra attack.

Tags: Iran, Oil and Gas

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