Turning on the taps

Published in The Gulf, 1 August 2015 Iran’s oil and gas sector should be one of the areas that benefits most quickly from the deal with the US and other international powers.

The deal to remove sanctions on Iran has been widely seen as a diplomatic success story and one that heralds many potential benefits for Iran’s economy. It could hardly have come at a better time for the country’s energy sector.

The most recent oil statistics do not make happy reading for Iran. Crude oil production fell by 13 per cent last year to 3.1 million barrels per day (b/d) according to Opec, the oil cartel. That continues a decline seen since the most recent rounds of sanctions were imposed in 2012. Crude exports were 1.1 million b/d last year, down from 2.5 million in 2011, and petroleum export revenues were just under $54 billion, compared to $115 billion three years earlier.

Iran has some 157 billion barrels of crude oil reserves, the fourth largest reserves in the world. It’s reserves natural gas estimated at 34 trillion cubic metres are the second biggest in the world after Russia and account for 18 per cent of the global total. But the sanctions have meant that its ability to exploit and sell its riches has become increasingly difficult. The number of customers has dried up and revenues from sales that Iran has been able to make have been held in frozen bank accounts, which it cannot access.

Just how quickly the Iranian oil industry will be able to turn things around remains to be seen, but the signs are that it will be able to make some quick gains once the Vienna deal has been implemented and sanctions have been eased. Of course, that in itself is not a wholly straightforward process. As Mofid Securities, a Tehran-based investment and brokerage firm, points out, the deal first needs to gain approval from the US Congress, Iran’s Supreme National Security Council and the Majlis (parliament). The UN’s nuclear inspector, the International Atomic Energy Agency (IAEA), will also need to confirm that Iran is meeting its obligations before any sanctions are lifted.

All those things will take perhaps six to nine months, meaning that Iran still has to wait a while longer before it is in a position to sell its oil and gas freely on the international markets. Nonetheless, Iranian officials have been striking optimistic notes about how quickly the country can make progress.

“Iran has plans to increase its natural gas production to one billion cubic meters per day and its oil recovery to 4.7 million barrels per day within the next three years,” said oil minister Bijan Zanganeh on 20 July, at a meeting in Tehran with Sigmar Gabriel, the German minister for economic affairs and energy.

If Iran is to meet such ambitious targets, it will need to bring in international companies to offer both investment and expertise. As Gabriel’s presence in Tehran indicates, international companies are well aware of the potential of the market and many are keen to get involved. However, the process may not be all that straightforward, even once sanctions are dismantled.

Mark Fitzpatrick, director of the non-proliferation and disarmament programme at the International Institute for Strategic Studies (IISS), warns that many companies could be slow to throw themselves into the market. “A lot of companies are going to be reluctant to invest anything in Iran,” he says. “They’re going to be hesitant for some time.”

Others agree. One UN official says that he expects international companies to remain wary of entering the Iranian market for some time. He points out that even after the implementation of the UN deal, there will still be some US sanctions in place and there are provisions for the UN measures to be re-imposed in the future if Iran fails to stick to its commitments.

“My guess is that because this is a long-term deal and because there are ‘snapback’ provisions on the UN sanctions, that companies will have concerns about getting involved very quickly. They’ll want to see how the system develops,” he says.

It appears that large international oil companies (IOCs) from Europe and Asia will be the first to re-enter the market, with their US counterparts likely to be more wary. Iran says it has already begun talks with some European and Asian IOCs to explore the potential for foreign investment, although no new deals have yet been announced. Iran is preparing to offer a new contract model for the development of oilfields, known as the Iran Petroleum Contract, and the reaction of IOCs to the terms of those deals will be crucial.

Despite all these challenges, there should still be some things that do happen quickly that will enable Iran to strengthen its energy sector and build up its production and exports. Perhaps the simplest issue will be getting access to the money from previous oil sales that is stuck in frozen bank accounts. Estimates of the amount of money in these accounts have ranged as high as $100 billion, although the governor of the Central Bank of Iran, Valiollah Seif, recently insisted the actual figure was $29 billion.

Some critics of the deal with Iran have voiced concerns that this money will enable Iran to cause more mischief in other parts of the region, allowing them to channel more support to groups such as Hezbollah and Hamas, or to the beleaguered Syrian regime of Bashar al Assad. Others doubt that. Richard Dalton, an associate fellow at London-based think-tank Chatham House and a former British ambassador to Iran, says the funds will be used primarily to restore capital investment and strengthen public finances.

Iran will also be able to start selling the crude oil that it has already pumped out of wells and that is currently in storage. Capital Economics, a London-based research firm, says that the extent of these stockpiles is unclear, but estimates range from 10 million to 40 million barrels.

“They’ve already got a lot of oil in storage that could immediately be put onto the market and then they can start raising production,” says Jason Tuvey, Middle East economist at Capital Economics.

Even without international investment, some increases in production could still happen very quickly. Bijan Alipour, managing director of the National Iranian South Oil Company, the country’s largest crude producer, has said his company is ready to boost crude output as soon as sanctions are lifted.

“All required plans to boost oil and gas production in rich south oilfields have been prepared and we are ready to receive the instructions to start operations and return to the maximum level, before sanctions were imposed, in three days,” he said on 20 July, according to local press reports.

Despite this, reaching the targets set out by Zanganeh will not necessarily be easy. Iranian crude oil production was 3.6 million b/d last year, down from a recent high of 4.4 million b/d in 2011. The oil minister wants to take this back up to 4.7 million b/d by 2018, a level it has not been at since the late 1970s, before the revolution.

SVB Energy, a US-based research firm, says that Tehran is probably capable of adding up to 600,000 b/d of oil production within six to 12 months. It expects that by 2020, once some projects on the West Karun oilfields have been completed, it will be able to add a further 650,000-700,000 b/d of output. However, it also notes that to reach these mid-term targets, Iran will need to raise at least $70 billion of investment. SVB concludes that it will take at least three to four years from the time that Iran gains access to international investment and technology for it to regain its pre-sanctions oil production capacity.

Gas exports could take even longer to build up. Natural gas production was 173 billion cubic metres for the whole of last year, equivalent to around 473 million cubic metres per day and Zanganeh is aiming for one billion cubic metres per day by 2018, which would be the highest on record.

Fitch Ratings suggests that it could take several years for Iran to rebuild its infrastructure and take production up to a high level, particularly when it comes to developing liquefied natural gas (LNG) facilities.

“It will take at least five years to ramp up production and build the pipelines necessary to become a large gas exporter,” the ratings agency said in a report issued on 10 July. “The higher cost and complexity of LNG projects means significant LNG exports would take a decade or longer to materialise.”

The final matter worth considering is how much money Iran will be able to earn from its exports. Here too there are complications. Even if it does manage to boost production levels significantly and quickly, the revenues may not recover quite so rapidly. The extra Iranian supply is likely to lead to further falls in international oil prices and keep them subdued for several more years.

“If and when Iranian oil exports begin to come back to the market, they should put further downward pressure on prices,” says Tom Pugh, an analyst at Capital Economics. “It will reinforce the existing oversupply in the market. Increased supply from Iran and Iraq should help to cap the price of Brent at $70 over the next few years, even as demand from China and the US increases.”

While the outlook is certainly far brighter for Iran’s energy sector than it has been for many years, it will still throw up some challenges for policy makers in Tehran.