Post-sanctions Iran could be the next booming petrostate

Obsession
Energy Shocks
Obsession
Energy Shocks

As the world’s six major powers negotiate a nuclear deal with Iran, US and European oil companies are already eyeing the potential benefits of reinvesting in the country’s petroleum sector. If sanctions are eased, they are well positioned to provide the advanced technology and equipment Iran needs to further develop its oil and gas industries.

Iran has major potential because it holds the world’s fourth largest oil reserves and second largest natural gas reserves. The Islamic Republic is highly dependent on petroleum resources for government revenues. Growth has been crippled, however, by the costs of an eight-year war with Iraq, periods of low oil prices, and international sanctions.

Iran’s inability to get access to foreign investment and new technologies forced it to cancel projects to explore new oil fields and develop refineries. Its capabilities have fallen significantly behind its oil-rich Gulf neighbors.

The immediate global impact of greater energy production by Iran would be uneven, however, even if sanctions are lifted. Increasing production would face major challenges, at least in the short run.

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A petro-relationship

American oil companies began buying Iranian oil in the 1940s through contracts with the Anglo-Iranian Oil Company. After World War II, Iran became an anchor of US foreign policy in the Middle East for a quarter of a century. The relationship was based on energy trade and common security concerns during the Cold War. Interest in Iran’s petroleum industry ran so deep that the United States and Britain orchestrated the overthrow of prime minister Mohammad Mossadeq after he nationalized the Anglo-Iranian oil company in 1953.

In 1979, on the eve of the revolution, Iran exported 700,000 barrels per day (bpd) to the United States, accounting for 8.6% of American oil imports, according to Oil & Gas Journal. Amoco, Exxon, Mobil, and Shell were among the companies importing Iranian crude oil. By the late 1970s, US companies had also invested $457 million in Iran’s oil industry. The relationship changed after the monarchy was overthrown. The Carter administration began banning oil imports from Iran after the 1979 takeover of the US embassy.

Through subsidiaries, American oil companies continued to buy Iranian oil—worth up to $3.5 billion a year—off the international market in Rotterdam until the mid-1990s. In 1994, U.S. companies purchased more than 600,000 bpd from Iran, around 23 percent of Iran’s oil exports.

In 1995, president Hashemi Rafsanjani attempted to thaw relations with the West by offering a $1 billion contract to the US oil company Conoco, the most lucrative oil deal Iran had ever offered any foreign company. The Clinton administration, under Congressional pressure, blocked the deal and expanded sanctions. France’s Total picked up the contract.

Over the years, Washington has imposed escalating waves of sanctions on Tehran on three broad subjects: support for terrorism, failure to comply with UN resolutions on its nuclear program, and human rights violations.

In 2011 and 2012, the United States and European Union imposed the harshest round of sanctions to date. In mid-2012, Iran’s oil exports plummeted from 2.5 million bpd to 1.4 million bpd, their lowest levels since 1986. The limited sanctions relief in the 2013 interim nuclear deal allowed Iran to modestly increase its export of condensates to China and India, but progress has leveled off since then.

Sanctions have taken a toll. Iran produced six million barrels of oil per day during the final years of the monarchy in the late 1970s. But it has since struggled to maintain production levels. By early 2015, Iran only produced around 2.8 million bpd and exported around one million bpd. Despite its large reserves, Iran could barely meet its domestic natural gas needs in 2015.

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Western interests

Western companies clearly have an appetite for doing new business with Iran, if sanctions are lifted. In the early 2000s, Chevron and Conoco expressed interest in developing Iran’s South Pars gas field and Azadegan oilfield. In late 2013, shortly after the announcement of an interim nuclear deal, an unnamed US oil executive told Reuters, “We’re willing to talk: Iran’s got tremendous potential… Once sanctions are removed, we’d definitely be interested in investing.”

European companies, including Total SA of France, ENI of Italy, Royal Dutch Shell, and British Petroleum (BP), are also keen to resume oil investments in Iran. Some continued to operate in Iran long after their American counterparts left, but were forced to scale back activities after sanctions in 2011 and 2012.

Tehran is eager to revive Western investment in its oil and gas industries, too. Since president Hassan Rouhani took office in 2013, Tehran has courted Western oil companies. Rouhani’s oil minister is Bijan Zanganeh , who has been labeled Iran’s “second foreign minister” in the local press. During his previous stint as oil minister from 1997 to 2005, he signed deals with foreign companies that brought billions of dollars of investment to Iran’s petroleum industries.

Oil companies have so far been cautious about responding. A nuclear deal might ease tensions in US-Iranian relations and end some sanctions. But Washington is unlikely to lift all sanctions without a change in Tehran’s support for terrorism and human rights abuses. US oil companies would be less likely to invest in Iran until all types of sanctions are lifted.

Global prospects

New oil and gas exports from Iran could have a global impact. First, Iran’s return to the market and an increase in its oil production could offset the effects of supply disruptions—and the resulting spike in oil prices—from political crises in Iraq, Libya, and other conflict zones. It could also keep prices low. On April 7, the U.S. Energy Information Administration noted that removing oil-related sanctions on Iran, in the event of a comprehensive nuclear deal, could lower its 2016 oil price projections by $5 to $15 per barrel.

Second, increased production could eventually create more options for countries dependent on oil imports, especially as petroleum needs rise in the developing world. Some countries, such as Japan and South Korea, are already dependent on Iranian oil. Along with China, India, and Turkey, they buy virtually all of Iran’s liquid fuel exports.

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Third, Iran’s reemergence in the global market could have geopolitical implications, especially as Europe’s dependence on Russia, a large oil and gas producer, are strained over the crisis in Ukraine. Iranian officials have openly talked about providing an alternative to Russia for European energy needs. In September 2014, Rouhani told Austrian president Heinz Fischer that “Iran can be a secure energy center for Europe.”

Iran holds nearly 17% of the world’s natural gas reserves, and it is home to the South Pars field, the largest natural gas field in the world. Iran could begin exporting natural gas to Europe as early as 2020 if sanctions are lifted, according to experts.

The losers

Opening up Iran’s petroleum industry could also negatively affect the current balance among oil powers. Some countries would not welcome a new burst of Iranian oil and gas on the market. First on the list would be oil producers, including some neighboring states that already feel threatened by Tehran. They could face new competition in international markets. Oil-producing countries would also take a hit if Iranian oil and gas cause oil prices to drop further.

Second, some countries that import oil have received discounts from Iran as incentives to buy, despite sanctions. China, India, Japan, South Korea, and Turkey all received discounts, which might be eliminated if sanctions are lifted and Iran has a wider array of buyers. Their energy costs could go up, with a rippling economic effect at home.

Costs and obstacles

A few major roadblocks are likely to prevent Iran’s oil and gas industry from reaching its full potential anytime soon. One challenge is cost. Iran’s oil and gas sector needs between $130 billion and $145 billion in investments by 2020; with current oil prices so low, the price tag may be unpalatable to oil companies.

An increase in Iranian oil production is unlikely to have immediate impact, since the global energy market is currently oversupplied. In November 2014, Zanganeh claimed that the Islamic Republic could increase oil exports to four million bpd within three months of lifting sanctions, but experts believe it could take up to five years to reach that goal.

New exports of natural gas would also require expensive new pipeline infrastructure or liquefaction facilities that make it easier to export. Building this infrastructure would cost billions of dollars and take years.

Even if sanctions are eased, relations between Tehran and Washington will continue to be strained. Some sanctions will remain on Iran because of the government’s support for terrorism and human rights abuses.

But the country is too big a player to be ignored in a world increasingly hungry for energy resources. It has the longest coast along the Persian Gulf, through which around 40% of the world’s oil is transported. Iran demands reconsideration. And it may well get it.

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