by Sara Vakhshouri
In the past several days—despite the conflicts affecting Iraq, Syria, Iran and Russia—oil prices have been on a downward trend, hitting their lowest number in the past four years. As of October 2014, oil prices are more than 20 percent lower than June. This trend started with Saudi Arabia reducing its crude oil prices without cutting its production—the result of a strategic shift in Saudi policy. Previously, the swing producer in the market would maintain a general higher price range. Now it has shifted to increasing market shares by offering lower prices to its customers. Iran, the United Arab Emirates (UAE) and Iraq also followed the kingdom’s lead and offered discounts on their crude oil in order to maintain their market share.
This raises a number of interesting points. On the one hand, the acceleration of higher energy efficiency, combined with higher energy prices, the economic crisis in Europe and lower economic growth in China have all put pressure on overall energy demand growth. On the other hand, the global energy supply has had a bullish growth mainly because of the shale oil boom in North America and Iraqi oil output. Yet the lower growth of demand and the higher rate of supply growth have both altered concerns over energy security paradigms, shifting from the security of supply to concerns about the security of demand and the profitability of oil production (in the case of unconventional oil). Keen competition among producers to maintain market share, concerns over the unconventional oil production’s profitability, and the effect of lower oil prices on oil dependent economies are all consequences of this broader change in the balance between supply and demand in global energy markets.
Stabilizing the Demand
Although it might take longer to see the real effects of lower oil prices on global oil demand growth, lower oil prices will have a positive effect on the demand side. Lower prices could particularly strengthen the demand in countries that lack fuel subsidy regimes as price fluctuations may have a more tangible effect on consumers.
Oil Dependent Economies
The economies of conventional oil producing countries (particularly OPEC producers such as Bahrain, Kuwait, Saudi Arabia, Iran and Iraq) are highly dependent on oil for around 80 percent of their national budgets. There is a close correlation between oil prices and their fiscal maneuverability. For example, Russia, Nigeria, Bahrain, Venezuela and Iran have national budgets that work under a scenario of $100 per barrel of oil. Saudi Arabia’s budget for 2014 is meanwhile based on oil at $90 per barrel, and remaining OPEC members have set their 2014 budgets according to a $70 per barrel range. The current drop in prices has the potential to negatively affect some of these countries’ economies. But on the flip side, it could also encourage them to reduce their dependency on oil revenue in the medium to long-term. Lower oil prices also reduce the gap between global market prices and local prices, decreasing the amount of subsidies these countries have to pay for domestic fuel consumption.
Unconventional Oil Production
The extraction of unconventional resources does not only require a high level of technological proficiency, it is also very costly compared to conventional production. For most of the United States’ tight oil resources to be economically developed and produced, oil prices should remain at least around $70 per barrel in the long-term. With current costs, it is expected that the overall tight oil production will drop to about 20 percent with a downturn of oil prices below $70 per barrel. If oil prices drop below the range of economically profitable production, the drilling of new wells, for maintaining production levels, will mostly stop and tight oil production will reduce significantly within a period of between three to six months. The more recent price drops have reduced the profit margin of investment in US unconventional oil resources and have reduced the gap between current global oil prices to shale oil production costs to about only $20 per barrel. This has raised concerns for investors and could affect the likelihood of their further investment in unconventional oil extraction.
Back to Iran?
As I mentioned earlier, the costs of unconventional oil extraction are much higher than conventional oil production, particularly in the Persian Gulf region. Lower profit margins due to lower oil market prices could divert investor attention and interest back to conventional oil production in the Persian Gulf. Sanctions aside, Iran could possibly benefit from this situation due to the political and security crisis in Iraq. Indeed, due to the ongoing attacks by Daesh (ISIS or ISIL) in Iraq, most international investors have left the country. Iran, with its new investment regulations, could accordingly attract foreign investors to its energy industry once again. However, lower oil prices and high competition among the major oil producers to maintain and increase market shares could increase the stakes in maintaining the limitations on Iran’s oil exports and prevent this country from increasing its production.
]]>Iran’s oil sector is like an ageing wrestler who could still surprise opponents with a show of strength. With this essential industry currently flat on its back, President Hassan Rouhani’s team has to find a way to get their champion back on its feet. Meanwhile, international oil companies are looking on from [...]]]>
Iran’s oil sector is like an ageing wrestler who could still surprise opponents with a show of strength. With this essential industry currently flat on its back, President Hassan Rouhani’s team has to find a way to get their champion back on its feet. Meanwhile, international oil companies are looking on from the sidelines, and whispering some encouragement.
Iran’s revival would have a significant impact on global oil markets — and, in the longer term, on gas. Oil minister Bijan Zanganeh has predicted exports of 1.4 million barrels per day (bpd) this year, up from 1.15 million bpd in 2013.
Recent reports have indicated that Russia would swap equipment and goods for up to 500,000 barrels per day of Iranian oil, and that Chinese state trader Zhuhai Zhenrong was negotiating for a new contract to purchase condensate (extra-light oil). China currently accounts for about half of Iran’s reduced volume of exports. Although cracks may be appearing in the sanctions edifice, a full and rapid recovery will require the removal of sanctions, not just loopholes.
In such an eventuality, there will have been some permanent loss of capacity because of lack of investment but a re-emergent that Iran might be able to produce around 3.6 million barrels per day, compared to over 4 million bpd in 2010. This would equate to some 1.9 million bpd of exports, almost double current levels. With the US’s Energy Information Administration forecasting the call on OPEC to fall by 0.5 million bpd in 2014, and Iraq likely to grow by 0.3-0.5 million bpd, other OPEC members — notably Saudi Arabia — would have to cut back significantly.
Technically speaking, Iranian oil production might return much quicker than most observers expect. If the fields were shut down in an orderly manner — and the Iranians had plenty of warning — there is no reason why the closure should have permanently damaged them. Quite the opposite: a period of reduced production from some of the old fields may have allowed pressure to recover and more oil to drain into layers from where it can be recovered.
But the process of unpicking the multi-layered sanctions — US, EU and UN — will be lengthy and complicated. Different sanctions cover financial transactions, access by Iran to its overseas funds, trade in precious metals and petrochemicals, investment in the Iranian oil industry, the supply of refined products, the provision of technology, shipping and insurance, imports of Iranian oil by the US or EU, and dealings with numerous designated entities. Some of these sanctions date back well before the current nuclear crisis, and are predicated on support for terrorism or human rights violations.
So even a comprehensive deal over the nuclear program will not remove all sanctions, and certainly not all at once. President Barack Obama may have considerable discretion to waive the application of some sanctions, but it would be disconcerting for long-term buyers to know that a change in the political winds might again cut off Iranian oil at short notice.
To get much beyond 3.6 million bpd of oil output, and to continue the expansion in gas required to meet domestic demand and some ambitious export plans, the industry requires a comprehensive overhaul. Lists released so far seem more of a miscellany of favoured projects, with no clear prioritisation. Given other calls on the government’s budget, in a post-sanctions phase of economic recovery, external financing is likely to be required. Even more than that, international technology and expertise will be key.
With more than a hundred announced projects, the organisational capacity of the National Iranian Oil Company (NIOC) will be tested to the limit, after a long period of brain drain, underinvestment and politicisation. As the experience of Iraq shows — admittedly under less favourable circumstances — effective delivery of multiple megaprojects in collaboration with international oil companies can drag if the state company and ministry lack capability.
Stated priorities include the development of shared fields with Iran’s neighbours – Iraq, Kuwait, Saudi Arabia, Qatar and the UAE – to avoid hydrocarbons being drained across the international border. It has even been suggested that production-sharing contracts might be offered for such fields – which the international industry prefers to the ‘buybacks’ offered by Iran in the late 1990s, and the technical service contracts used in Iraq.
Iran’s production plans hinge particularly on a few large projects — the Azadegan and Yadavaran oil fields near the Iraqi border, which could produce 900 000 barrels per day; the completion of Phases 12, 15 and 16 of the giant South Pars field; and the Kish and Salman gas fields in the southern Persian Gulf, with potential output of 2.7 billion cubic feet per day, almost a fifth of Iran’s current production.
Salman is a cross-border field with the UAE, and its gas was intended to go to the Emirate of Sharjah, but the deal fell apart over allegations of corruption, under-pricing and Iranian failure to complete infrastructure. Kish has for some years been targeted for export to Oman, which has played a quiet but critical role in behind-the-scenes nuclear diplomacy. Qatar, with whom Iran shares South Pars (Qatar’s North Field), recently offered technical assistance on the field.
But NIOC also needs to consider how to sustain and revive output from its mature fields, including managing massive gas reinjection projects that will take years to show results. At the same time, it needs to explore for new fields with the modern technology and geological concepts that have been so successful just over the border in Iraqi Kurdistan.
Iran has long been working with Chinese companies on Azadegan, Yadavaran, and the Iran LNG (liquefied natural gas) project, part of South Pars. But it has become frustrated by what it sees as their low technical competence and foot-dragging over full-scale investments. Western companies are back in favour. Firms such as ENI and Shell have already, with surprising alacrity, held some discussions with Mr. Zanganeh. During an initial phase of sanctions removal, international companies may seek short-term technical assistance deals — building goodwill and positioning themselves, without making major commitments until they can judge to which side the political tussles, internal and external, incline.
International companies — mostly Western, but also including firms such as Malaysia’s Petronas — bring skills in megaprojects, managing mature fields, and exploration. But Iran should think not only in terms of attracting industry titans — it has plenty of smaller fields where nimble newcomers and private Iranian companies can perform better.
With such assistance, the champion can still return to the fray at something like its former strength. Increased oil output challenges Iran’s Arab neighbours, while gas exports allow it to build ties with the UAE and Oman, as well as with Iraq, Turkey and Pakistan. That will be essential for President Rouhani’s administration, giving his team the muscle to revive the economy. Recapture of the commanding heights of the oil industry and its finances — plundered and obscured under President Mahmoud Ahmadinejad — is essential in the country’s byzantine factional contests. As usual, this slippery liquid is the way to keep a firm grip on the economy and body politic.
Photo: Iran’s Oil Minister, Bijan Zanganeh
]]>by Robin M. Mills
Hassan Rouhani is known as a man who sprays air-freshener in the room before a meeting. When it comes to Iran’s oil industry, Iran’s fastidious president-elect may have a great deal of spring-cleaning to do.
Much outside attention has been paid to the impact of sanctions on Iran [...]]]>
by Robin M. Mills
Hassan Rouhani is known as a man who sprays air-freshener in the room before a meeting. When it comes to Iran’s oil industry, Iran’s fastidious president-elect may have a great deal of spring-cleaning to do.
Much outside attention has been paid to the impact of sanctions on Iran and global oil markets. There has been less discussion of what Iranian policymakers should be doing with their oil, and what effect different policies would have within the country. Turning around the petroleum sector is crucial to Iran’s economy, and in turn, to the success of the centrist-reformist current that the pragmatic Mr. Rouhani is now representing.
During the phase of post-war reconstruction under Akbar Hashemi Rafsanjani, oil production rose by more than 3 percent annually and grew by more than 1 percent per year under Mohammad Khatami as major foreign investment flowed in from European, Russian and Asian companies. In 1995, Bill Clinton vetoed a contract for US oil company Conoco to develop the offshore Sirri fields, which allowed France’s Total to step in. The National Iranian Oil Company (NIOC) as well as domestic engineering and service companies also significantly improved their technical capabilities.
In contrast, the economic consequences of Mahmoud Ahmadinejad were oddly similar to those of Hugo Chávez in Venezuela — the replacement of skilled oil technocrats by less qualified allies, leading to stagnant output. Two giant oil field discoveries of the early 2000s, Azadegan and Yadavaran on the Iraqi border, have barely been developed.
Driven by South Pars, the world’s largest field — shared with Qatar — natural gas production continued to rise impressively under Ahmadinejad, albeit at a slower rate than with his predecessor. But with lines being drawn all over the map like spaghetti, minimal progress was made on gas export plans — to Turkey and Europe; Pakistan and India; the UAE, Bahrain, and Oman — and as liquefied natural gas. The country that, according to British Petroleum, now has the world’s largest reserves, is barely a net exporter of gas.
Development of the oil sector was, of course, hampered by increasingly tight sanctions. Western companies essentially suspended new activities by 2008, while Chinese and Russian firms did no more than keep a foot in the door. But bigger barriers — already apparent during Khatami’s second term — were unattractive contract terms, interminable negotiation periods and decision-making paralysis.
Three of Ahmadinejad’s nominees for oil minister were rejected by the Majlis in 2005; in 2011 he attempted to act as his own oil minister, again ruled out by parliament. As Kevan Harris has documented, from 2006, Ahmadinejad accelerated a process already underway since the 1990s — the pseudo-privatisation of a wide range of state-controlled entities, including oil development and engineering companies and petrochemical plants. In a process reminiscent of the “nomenklatura capitalism” of post-Soviet Russia, many of these companies have fallen under the control of regime insiders and government bureaucrats.
High and rising oil prices permitted complacency as Iran received more oil revenues than in the entire previous century of production during Ahmadinejad’s two terms as president. An increasingly overvalued exchange rate made domestic industry uncompetitive and attracted a flood of cheap imports in a vain attempt to keep down inflation sent soaring by excess liquidity. In a curious reversal of monetary orthodoxy, Ahmadinejad insisted that interest rates not exceed the inflation rate.
The main positive achievement of Ahmadinejad’s administration was reforming Iran’s ruinous energy subsidy scheme, which was replaced by direct cash payments to families. The plan was conceptually sound and surprisingly well-executed; consumption fell and the basic income provided made a substantial difference for poorer Iranians. But the scheme stalled as a result of further infighting between the Majlis and president, the sanctions-induced collapse in the rial, severe inflation and the failure to compensate affected businesses.
The administration did not anticipate how successful the US would be, from early 2012 onwards, in cajoling both allies and rivals to eliminate or cut oil purchases from Iran, as well as targeting insurance, shipping, financial transactions and exports of other Iranian products. Iran’s oil sales fell by a million barrels per day, while increased output from Saudi Arabia and from the US itself prevented global prices from rising too far.
The path of Iran’s oil industry under Dr. Rouhani will depend on progress made in nuclear negotiations and the easing of sanctions, as well as his administration’s domestic policy choices. A military conflict with the US and/or Israel would have highly unpredictable but damaging effects on Iran’s oil industry and possibly those of its neighbours.
If the current sanctions regime remains in place, Iran’s new administration will have to do its best to survive on a severely diminished income. As the Mossadegh government did in the early 1950s under somewhat similar circumstances, it can reorient the economy further towards domestic production and consumption, eliminating the luxury imports that boomed over the past decade. Better management and tackling corruption would reduce the social impacts and inequality — at the potential cost of harming some leading regime figures.
Bringing back Iran’s capable technocrats — and some of its talented diaspora, with more relaxed social conditions, as under Khatami — would keep oil production steady. Two candidates helped manage Rouhani’s campaign – former deputy oil minister Akbar Torkan and former refining and petrochemical chief Mohammad Reza Nematzadeh. Discounts, loopholes and disguised shipments can maintain exports, even at a reduced level. Over time, the enforcement of the sanctions can be eroded.
But, with the demand for OPEC oil set to be stagnant or falling over this decade, the prospect of lower oil prices, and Iraq’s taking an increasing share of the pie, the path ahead could be hazardous. Iran’s purported ally Russia has no interest in encouraging a competing oil and gas exporter. Given the Islamic Republic’s paranoid (if not unjustified) suspicion of the West, it would be ironic if it ended up yet more dependent on the Kremlin and China.
In the event of a breakthrough on the nuclear issue, and a lifting of most oil-related sanctions, the stage would be set for a pragmatic, Rafsanjani-style reconstruction. If the shutdown could be managed correctly, oil production could bounce back to near pre-2012 levels quite quickly.
But fully realising Iran’s petroleum potential requires foreign investment and expertise, ideally including Western companies. This will have to be under better contractual terms than the “buybacks” offered in the early 2000s that provoked so much nationalist debate within Iran.
Giving international companies a long-term stake in fields can be done with modern contracts that still provide Iran with full sovereignty and control over its industry. This would achieve two objectives. First, it would ensure efficient operations and maximum recovery from the country’s mature fields while encouraging technology transfer. Second, it would give momentum to the removal of remaining sanctions and create a barrier against their reinstatement.
In the same way, gas exports — to the GCC, Turkey and Pakistan — would anchor Iran more tightly within the regional economy and make it indispensable to its neighbours. The window for major exports to Europe has probably closed, with Azeri and Iraqi Kurdish gas set to flow. But Iran could still resurrect its liquefied natural gas plans, where it has fallen infinitely behind Qatar.
Domestically, Iran’s subsidy reform needs to be revived — more propitious when the economy is growing and government finances are increasing. The web of pseudo-privatisation also needs to be untangled and replaced by a balance of true private investment and commercially focused state enterprise.
The sine qua non is a resolution to the nuclear issue and an end to the major sanctions. A whole-hearted pursuit of these policies would amount to a revolution in Iran’s energy affairs — likely to provoke major domestic opposition and run into significant international hurdles. But even a pragmatic, technocratic house-cleaning of Iran’s oil sector would help set the economy on a path to recovery and give hope for the success of Dr. Rouhani’s tenure.
– Robin M. Mills is Head of Consulting at Manaar Energy and author of The Myth of the Oil Crisis and Capturing Carbon. Email him or follow him on Twitter.
]]>by Sara Vakhshouri
Sanctions against Iran by the European Union and the United States, which aim to change Iran’s attitude toward its nuclear program, have increased pressure on its oil export and revenue. This resulted in the reduction of Iran’s oil exports from 2.2 million barrels per day (bpd) in late 2011 [...]]]>
by Sara Vakhshouri
Sanctions against Iran by the European Union and the United States, which aim to change Iran’s attitude toward its nuclear program, have increased pressure on its oil export and revenue. This resulted in the reduction of Iran’s oil exports from 2.2 million barrels per day (bpd) in late 2011 to around between 900 thousand to slightly above 1 million bpd until October 2012. On 30 January 2013, Reuters reported that Iran’s crude oil exports hit its highest level in December, at around 1.4 million bpd since EU sanctions took effect last July. What was the reason for this sudden hike?
Seasonal Demand
Winter and summer months traditionally mark peaks in global fuel demand. The cold weather during November and December, compared to September and October, usually creates higher energy demand and consumption. As expected, heating fuel consumption increased during the last two months of 2012, particularly in the US, Japan and other members of the Organisation for Economic Co-operation and Development (OECD), due to colder than normal weather conditions. According to the Energy Information Administration (EIA), the global demand for liquid fuels surpassed production in November and December 2012 due to seasonal increases in consumption. This caused a 1.4 million bpd draw from the global oil stocks. The average global demand for liquid fuels in November and December 2012 was estimated at around 90.2 million bpd, or about 0.9 million bpd higher than the consumption of September and October. However, the global supply outside of Iran was about 86.7 million bpd during this period.
Easing of Shipping Restrictions
Iran has increased its shipping capacity by purchasing super tankers from China. It also decreased its oil production, which eased the country’s shipping capacity. Beginning with the EU oil embargo in July 2012, Iran had to use some of its tanker capacity to store its extra production while searching for buyers. After it made an adjustment between its production, domestic consumption and average monthly export, this shipping capacity was free to transport crude oil. Increases in Iran’s tanker capacity allowed Iran and its customers to skirt the EU ban on tanker insurance. Iranian tankers could, in some degree, transfer oil to its customers. Market data suggest that China, Iran’s biggest oil customer, imported 593,400 bpd of oil in December. According to Chinese officials, an easing of shipping delays was the reason behind this increase. This could suggest that some of this amount might have been from purchases made in previous months that reached China with a delay.
US Waivers
The US State Department grants 180-day waivers on Iran sanctions to countries that prove they have reduced their Iranian purchases. State Department officials, though, have not insisted on any specific percentages for these waivers. Countries are expected to reduce the average amount of their purchases from Iran compared to previous purchases. These countries can adjust their purchase amount from Iran based on their monthly demand and the available supply in the market. This means they can increase their purchase of oil during high demand season and adjust it during the months when demand is relatively lower.
Senators Robert Menendez, an architect of US sanctions legislation, and Mark Kirk, have urged President Obama to require oil importers to reduce purchases by 18 percent or more to qualify for further waivers. Iranian oil customers are expected to maintain the average of their purchase from Iran at around at least 18 to 20 percent lower than pre-sanctions purchases during each period of 180 days in order to have their waivers renewed. We are therefore expecting the average Iranian oil exports to remain at around 1.1-1.2 million bpd throughout 2013.
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