With sanctions now lifted, Richard Robinson, Global Energy Fund Manager for Ashburton Investments assesses the next steps in Iran’s comeback to world energy markets.
On the 16 January, following confirmation from the UN’s International Atomic Energy Agency (IAEA) that Tehran had fulfilled its obligations under an agreement last summer to limit its nuclear programme, many of the existing sanctions imposed on Iran were lifted by the EU, US and Norway. The lifting of the sanctions is the latest chapter in a long running saga dating back to 2002, when Russian technicians began constructing Iran’s first nuclear reactor at Bushehr, despite strong US protestations. This culminated in sweeping sanctions being imposed in 2007, which were later extended in 2012, together with the European Union’s boycotting of Iranian exports. The sanctions were considered to be some of the toughest and most far reaching in a series of sanctions imposed over the last 30 years.
Since the exit of the volatile President Ahmadinejad and the election of reformist backed President Rouhani, US/Iranian relations have seen a distinct ‘thawing’. The implications of this shift has, and will, continue to have significant ramifications for not only the energy landscape but also the Shia/Sunni hegemony within the region.
Iran possesses the fourth largest oil reserves and the second largest gas reserves in the world, something its recent production history has belied. Its production profile has been checkered, to say the least, blighted by underinvestment in the energy industry thanks to a combination of international sanctions, a largely dysfunctional economy and poor management.
In 1973, under the Shah’s rule, Iran produced just over 6 million bpd . Production then plummeted to under 1.5 million bpd in the early 80s following the revolution in 1979. Since then, Iranian production steadily recovered and in 2011 stood at just over 4Mbbld (exporting circa. 2.5 million bpd). However, thanks largely to the aforementioned sanctions, the lack of investment and the restricted export opportunities open to the country, recent production dipped towards the 2.8 million bpd mark (and exports fell to about 1.2 million bpd). As a result, Iran is 1.2 million bpd away from its pre-sanction level and 1.3 milliom bpd away from its pre-sanction export level. The questions are: Can Iran reach its target of raising production by 1 million bpd within 12 months, and what sort of production is the world’s oil market going to have to absorb from Iran?
In the short-term, we will see an immediate pick-up in Iranian exports. Iran has 47 million bbls of oil stored in offshore vessels and Iranian barrels are likely to back out similar quality sour crude from Saudi Arabia, Iraq and Russia. This oil will not hit the market at once, instead we are hearing that it will initially release those reserves at a pace of 500 000 bpd (approximately a 0.5% increase to global oil market supply), with much of this increase being supplied from the 47 million bbls of floating storage. Production increases are expected to be around 100 000 bpd for the first month but rising to the Iranian government’s 6 month target of 500 000 bpd within six months. Consequently, the 47 million barrels of storage will probably be drip fed into the market at a compensatory rate for any production shortfall in relation to their stated 500 000 bpd target. Iranian storage will probably last around 6 months, depending on how quickly production can be increased. Once emptied, the ‘targeted’ Iranian increase of 500 000 bpd and their subsequent 12 month target of hitting an increase of 1Mbbld will have to come entirely from production increases – something that will require significant external investment; they hope to attract between US$100 to US$150 billion over the next 5 years.
However, new investment may be frustratingly slow! Although European companies, including Total SA of France, ENI of Italy, Royal Dutch Shell and British Petroleum (BP), have indicated interest in resuming oil investments in Iran, there remain a number of significant obstacles to overcome. Consequently, Iran’s eventual target of boosting output by 1Mbbl by the end of the year may take longer than some anticipate and is a target that has already been somewhat softened by the likes of Rokneddin Javadi (Chief of the state owned National Iranian Oil Company). In order to reach the targets, investment and ‘know how’ are key. It should be remembered that a number of sanctions still remain and Javadi points to the continued restrictions faced by Iran’s banks as presenting one of the major obstacles to reaching the production targets. Amongst some of the remaining sanctions, dollar based clearing restrictions remain in place.
Because UN, US, and EU commitments vary widely, for the first time in many years, US and EU sanctions are no longer ‘in sync’, something that raises significant compliance challenges for financial institutions who are subject to both US and EU rules. Therefore, financing of Iranian activities will, most probably, be reliant on Chinese banks or European financial institutions that don’t do business in the US.
During the sanction years (particularly over the last five years), the financial constraints and the starvation of capital investment meant that large swathes of the industry were placed into the hands of the Iranian Republican Guard (IRGC) – and here lies one of the myriad of issues with regards attracting foreign investment. The IRGC is responsible for the protection and survival of the regime and the prevention of foreign interference in the Islamic state. The IRGC has extensive, opaque but far reaching economic interests, many of which encompass the E&P and oil service companies. Any attempt to execute future projects without their involvement will be very difficult.
With the fourth largest oil reserves (157 billion barrels) and the second largest gas reserves in the world, there is bound to be a degree of pragmatism, but that doesn’t mean obstacles will disappear. Obstacles mean delays, opaqueness equals risk and risk is cost; cost that can be prohibitive e.g. increased financing costs.
The US bans on dealing with the major IRGC affiliated company Khatam Al Anbia will remain in place. Khatam Al Anbia is Iran's largest contractor in industrial and development projects. It controls more than 800 companies, including many oil service companies. Europe has said that it may lift its exclusion to the company, but not for another 8 years. Pragmatism, however, means that some bans have been lifted on a number of IRGC tied companies (something that has not gone down well with critics of the Iranian regime). But remaining bans with such large entities such as Khatam Al Anbia present a problem (particularly as US equipment will not be allowed into the country).
European and US oil companies that are looking to invest in the Iranian energy industry will risk the frustrations of either not being able to deal with the many service companies that the IRGC are involved in or, if they are found to have dealt with them, risk a fall out with the authorities and their respective financial backers.
Such an eventuality will open up the prospect of massive fines (remembering BNP’s US$8 billion fine, last July!) and of being excluded from dealings in the US and Europe. Such an event could be crippling, particularly at a time when the oil price is low. Oil companies need to maintain strong financing relationships; access to short cycle US oil projects could be key when it comes to adjusting long-term oil production strategies going forward (from their current focus on long cycle, more expensive oil, to increasing production from lower cost, short cycle US oil).
Those looking at potential long-term involvement in Iran will also be aware of the fact that there could be some potentially ruinous contract clauses that are being drawn up by the Iranians. They include a clause that foreign companies are not to be released from their contractual obligations should the US, Europe or the UN impose sanctions. Oil companies will therefore have to be confident of a continuation of the more liberal, open Rouhani style regime for, at least, another 7 - 8 years (the timescale it will take to ‘break even’ on any new oil project) or that the current more ‘open stance’ from Western Governments will persist - particularly if a Republican government wins the next US election.
It would be brave for anyone to assume there will be seven years of political stability in Iran, particularly when Iran is faced with an escalation in the Sunni/Shia antagonism. Saudi Arabia patently does not want Iran back in the oil markets and seems likely to continue to provoke Iran at every opportunity. If Iran fails to respond, this will fuel the fire under the Iranian hardliners and further jeopardise Rouhani’s attempt to secure a second term as President in 2017. The other problem that Rouhani faces is the issue of delivering on his promise of economic recovery. Rouhani came to power on a mainly economic platform; a platform that, if he doesn’t deliver, may send him through the trap door. The combination of an ‘ambiguous’ lifting of sanctions, combined with a potential unwillingness for major oil companies to commit, manifests itself in an inability to raise production to the level required to compensate for the 75% dive in oil prices. Although the lifting of sanctions is expected to contribute a 5% boost to the Iranian economy, it may not be sufficiently quick to appease Rouhani’s critics domestically, or to pull it out of its deepest recession in thirty years (according to Ali Ahmadi, President of the Joint Committee of the Expediency Council).
Whilst we have focused on the obstacles to ramping up production to pre-2012 sanctions levels, there are some potential ‘positive’ post-sanction factors that may help production rise.
Firstly, some of the country’s core oil fields such as Ahwaz, Marun and Gachsaran, may have been ‘revived’ due to sanctions. Shutting down large volumes of oil may have allowed pressure to rise – leaving the fields capable of a swift production boost. Secondly, Iran unveiled the new upstream contract and 50 projects at a conference in Tehran in late November. It plans a similar event in the last week of February and its desperation to revive the industry has meant that contracts are shaping up to be a lot more generous than they were previously. However, as stated, the prospect of pre-nuclear sanctions remaining in place, combined with the possibility of sanctions being re-imposed should Iran fail to comply with the Joint Comprehensive Plan of Action (JCPOA) may put off foreign investors from committing to the required long-term investments.
Short-term targets (500 000 bpd over the next 6 months) will in all likelihood be met (topped up using existing offshore storage), but the longer-term target (1 million bpd in 12 months) is going to be a lot more challenging. However, there is simply too much oil at stake not to be pragmatic; it might just take time. Although we have turned the corner with regards to Iran’s return to international markets, the road ahead is not straight and is unlikely to be smooth or even that long, but there is too much oil at stake for it not to be travelled!
Adapted from a press release by David Bizley
Read the article online at: https://www.oilfieldtechnology.com/drilling-and-production/30052016/iran-return-to-international-energy-markets-a-rocky-road-ahead/