Prospect of sanctions' end highlights woes of Iranian oil and gas industry

March 3, 2014
Bijan Namdar Zanganeh, after being endorsed by the Iranian parliament as the new oil minister, said, "The revival of Iran's lost share in the oil market is my top priority."

Mansour Kashfi
Kashex International Petroleum Consulting
Dallas

Bijan Namdar Zanganeh, after being endorsed by the Iranian parliament as the new oil minister, said, "The revival of Iran's lost share in the oil market is my top priority." At the end of the Organization of Petroleum Exporting Countries ministerial conference in Vienna on Dec. 4, 2013, Zanganeh said, "Under no circumstances will we give up our rights on this issue; we will reach 4 million b/d [of oil] production, even if the crude price falls to $20/bbl, and we will be able to reach our presanctions level of exports early next year." The minister openly raised the prospect of a production war among OPEC members.

Zanganeh held the post of oil minister once before, in 1997-2005, under another reputedly moderate clergy president, Mohammad Khatemi. This time he envisions the aforementioned challenges. Can he accomplish them?

Iran's oil prospects

Iranian oil reserves are estimated at 157 billion bbl, the fourth largest in the world (OGJ Dec. 2, 2013, p. 30). After the cancellation of the International Consortium Agreement Area in 1973, Iran produced 6.1 million b/d of crude and exported an average of 5.5 million b/d, far above current levels.

A few weeks after taking office last August, Iranian President Hassan Rouhani invited western oil companies to meet him at United Nations General Assembly sessions. The Islamic Republic has desperately invited international oil companies to return to Iran under deals more attractive than they had been offered before and to showcase officials to American and European energy companies, including Zanganeh. At the end of the OPEC ministerial meeting, he signaled a new era of contract terms intended to be more appealing to international operators than those offered in his earlier term as minister.

According to a Financial Times report last October, Iran hopes to attract at least $100 billion in western investment in oil and gas development over the next 3 years. Details of new terms of participation were expected to be announced in London, where Iranian officials were to meet with mainly European international oil companies in April. But the meeting was later moved to November. Mehdi Hosseini, an advisor to the oil Minister, revealed that the government would reach out to old oil buyers and is ready to cut prices.

On Dec. 1, 2013, Zanganeh mentioned the names of seven international oil companies that he hopes will return to Iran: ExxonMobil, ConocoPhillips, BP, Shell, Total, Statoil, and ENI. "The contract terms will be ready in April of next year, once international sanctions are lifted," he said. Sanctions leveled against Iran by the US and European Union have had a crippling effect on the country's infrastructure and technological development. Oil revenues, which drive the country's economy, have decreased as much as 55% due to the sanctions.

According to the US Energy Information Administration (EIA), OPEC member countries in 2012, excluding Iran, made about $982 billion from exporting crude, the highest total since the EIA began tracing OPEC revenue in 1975. Iran, once OPEC's second largest oil producer and exporter, was not included in this report because of difficulties estimating Iranian earnings, including price discounts, rewards to customers, and the inability to collect payments from them, the EIA reported. Iran, by providing about 10% commissions to international money dealers and middlemen, usually circumvents some of the sanction on the transfer of oil money.

Iran's oil production in 2012, when effective EU sanctions were put in place, and in 2013, fell to its lowest level since 1986 in the midst of the 8-year-long Iran-Iraq war. Iranian revenue from selling crude oil and oil products in 2010 was $150 billion and gradually dropped under the sanctions. In 2011, oil revenues totaled $95 billion, then fell to $69 billion in 2012 and further decreased to about $32 billion (mostly in non-US currencies) in the first 9 months of 2013.

Iran has also urgently engaged in massive barter trade with Asian crude customers, including China, South Korea, and India. Oil exports provide 80% of the regime's revenue and 70% of its foreign exchange.

The Islamic Republic has extended its business with Russia. In November 2009, Lukoil and Gazprom of Russia and the National Iranian Oil Co. (NIOC) signed memorandum letters of understanding on the development of Azar and Changuleh oil fields by Gazprom and Aran oil field by Lukoil. These agreements have been transferred to Revolutionary Guard subcontractors. Reuters reported on Jan. 10 that an $18 billion/year deal, mainly in barter trade, is being negotiated between Russia and Iran that increase the Islamic Republic's oil exports by 500,000 b/d. However, this deal would violate sanctions, which under the Geneva agreement continue to limit Iranian oil exports to 1 million b/d.

US Sec. of State John Kerry said late last November, "The Joint Action Plan agreement in Geneva does not offer relief from sanctions with respect to any increase in Iranian crude oil purchases by existing customers or any purchases by new customers." He added, "We will pause for 6 months our efforts to further Iran's crude oil sales."

In Vienna, Zanganeh told reporters, "We can immediately return to full export capacity of 2.8 million b/d. We have no technical difficulties." He also added, "I will not accept any limitations for returning to our previous market and production that we had before."

Fields in decline

It is well known that major Iranian oil fields are old and in decline. More than 60% of Iran's crude oil production comes from oil fields discovered before nationalization of the oil industry over 60 years ago; naturally, production by many giant fields peaked long ago. Iranian oil fields also have been deprived of upstream technology available elsewhere. Supergiant oil fields including Gachsaran, Agha Jari, Ahwaz, Marun, and Parsi are in poor condition, with rapidly dropping pressures and rising water cuts. Reachieving prerevolution production levels is a dream, and attaining presanction production levels with the current system of operation would be difficult.

The Iranian oil industry has been brought into bankruptcy and partial ruin by neglect, ignorance, and the lack of investment and technology. Even if international sanctions were lifted, the recovery would not be instant. With ample investments and modern technology in hand, the Iranian oil industry would require 3-4 years to raise oil production back to its level above 4 million b/d before the tightening of sanctions in July 2012. Last year, according to EIA, the Islamic Republic produced an average 2.8 million b/d of crude oil.

Potential for gas

Iran has gas reserves of about 1.193 quadrillion cu ft, the second largest in the world and over 17% of the global total. About 437 tcf of Iranian gas is contained in the South Pars gas fields, the largest in the world.

Zanganeh, while visiting the Asaluyeh port on the Persian Gulf in March 2002 during his first term as oil minister, said the Islamic Republic "has had to face the heavy pressure and impediments of the US and Israel in the course of developing its South Pars gas field." He said Iran would gain $11 billion/year from gas sales when the projects were complete. More than a decade later, nothing is yet in sight.

Anticipating the lifting of sanctions, international oil companies, especially from Europe, show interest in engaging with Iran's oil and gas industry and crave access to hope Iranian natural gas as an alternative to expensive Russian supply. The huge reserves of Iranian gas are inviting, particularly to members of the EU and to eastern consumers, mainly Japan and China.

The initial deal for South Pars gas field was in the form of a memorandum of understanding with Total and Petronas of Malaysia for production of LNG from phase 11. This contract never materialized and, in 2009, was transferred to Total in its entirety. However, before severe US and EU sanctions were imposed, Christophe de Margerie, Total's chief executive, announced in mid-2009 that the Phase 11 deal was "not attractive enough." That was just a few days after Norway's Statoil announced that it would complete a South Pars project at the end of 2009 and no longer had any intention of investing in Iran. Furthermore, Total and Repsol withdrew from a joint Pars LNG project in 2009, and Shell also left another project, known as Persian LNG, incomplete in 2010.

Under a gas deal worth $4.7 billion, signed in Beijing in June 2009, Iran transferred the Phase 11 development project to China National Petroleum Corp. (CNPC). The project was to produce 50 million cu m/d of natural gas from South Pars field. There has not yet been any progress report.

Later in 2009, Iran and a Chinese consortium signed an agreement worth €2.5 billion for the production of 10.5 million tonnes/year of LNG. The contract should have been implemented within 36 months of being signed, but no progress report has emerged to this date.

Former Iranian Oil Minister Rostam Qasemi, in an interview with RIA Novosti in July 2012, revealed that South Pars Phases 13, 14, 19, 20, 21, 22, 23, and 24, with output capacity of 250 million cu m/day of natural gas, would be completed by Mar. 21, 2014, the Iranian New Year's Day. Further, the Oil Ministry's news agency, Shana, reported that during visits to the South Pars Phase 12 platform by the new oil minister on Dec. 2, 2013, and to the Phase 18 platform by the managing director of NIOC on Dec. 6, 2013, announcements were made by both men that phases 12, 15, 16, 17, and 18 would be completed by Mar. 21 and that gas production would be on system in May 2014. The development and production of South Pars gas field have been long delayed by deficiencies of management, investment, and technology in a country facing severe gas shortages year-round.

All that Iran has done for South Pars gas field has been the Tompack project in Assaluyeh port, negotiated by a consortium of China's energy companies, toward which no progress has been reported yet. However, Qatar, on the other side of the Persian Gulf and with less gas than Iran, currently is the largest LNG exporter in the world. According to the International Monetary Fund (IMF), Iran's per capita income was below $12,000 in 2012, whereas Qatar's was about $107,000.

During the 35 years since formation of the Islamic Republic, the country's oil and gas industry has claimed numerous discoveries of oil and gas, construction of refineries and production facilities, and completion of various phases of gas fields and pipelines. In reality, the industry has greatly underperformed its announcements, in many cases not performing at all.

Rationing and refining

The government in February 2009 began enacting a strict rationing of gasoline to compensate for limited domestic production of the fuel, imports of which represented about half of the total amount consumed. Ostensibly to prevent shortage, in late November 2009 the National Iranian Oil Refinery and Distribution Co. signed a tentative agreement with China's Sinopec to build five refineries and two production facilities in Iran at a cost of $23 billion. Rostam Qasemi, then oil minister, stated, "Construction of these new refineries shall increase Iranian total oil refining capacity from 1.65 million b/d at the present to 3.5 million." He further added, "These refineries will allow our country not only to meet domestic needs but also to be able to export large volumes of refined products."

On Feb. 1, 2010, according to the UPI, the Oil Ministry reported that the previously announced "Persian Gulf Star" complex of condensate splitters would be built in the coastal city of Bandar Abbas, with output capacity of 10 million gal/day. According to the report, the Persian Gulf Star would enable NIOC to export large amounts of surplus gasoline.

In early November 2013, the new oil minister announced an increase in fuel prices, blaming "smuggling of cheap Iranian fuel to neighboring countries." He said, "Our country imports over 6 million l./day of fuel" but made no mention of the fate of the Sinopec agreement or the Persian Gulf Star project.

Iranian pipelines

RIA Novosti in July 2012 revealed that NIOC finalized a deal with Iraq to export 30 million cm/day of Iranian gas by pipeline to Iraq to fuel three power plants. The "Islamic Pipeline," as it is called, was expected to deliver the gas to Iraq by March 2013, but that never happened.

Another project, known as the "Peace Pipeline," which for nearly 2 decades was very dear to Iran and its neighbor Pakistan and would have carried Iranian gas to Pakistan, India, and possibly to China, abruptly fell apart when Ali Majedi, the deputy oil minister, declared the Islamic Republic "is not able to finance construction of the pipeline in Pakistan and has no obligation to do so." The US has been pressing Pakistan to leave the Peace Pipeline and to focus on the proposed Turkmenistan-Afghanistan-Pakistan-India (TAPI) gas pipeline.

The Iranian ambassador to Ukraine last August, according to Shana, announced that Iran plans to export huge volumes of gas to Ukraine and Moldova, although these countries presently purchase the majority of their imported gas from Russia. Specifics about the pipeline and its route to Europe have not been revealed.

Furthermore, Oman has been arranging with Iranian officials to import Iranian gas across the Persian Gulf via pipeline since 2005, and an initial agreement was signed in 2007. However, nothing has been put in motion since then. Oman has been importing gas from Qatar across the United Arab Emirates since 2007. Because of the possibility of a lifting of sanctions, another gas supply agreement was signed last August, valued at $60 billion over 25 years. According to the deal, if materialized, Iran would export gas to Oman at a below-market price.

While signing several gas export agreements with neighboring countries, Iran also has been planning to deliver gas to Europe by various pipeline routes and has even planned to export LNG to East Asia. Yet Turkey is the only neighbor of Iran that receives Iranian gas, small amounts via pipeline. For the last decade, in fact, the Islamic Republic has been a gas importer, receiving supplies from Turkmenistan for domestic use in its northern provinces.

The fact is that the amount of Iranian gas produced now and probably for years to come is inadequate for domestic consumption and for oil recovery. Therefore, it is impossible for Iran to honor the present sales commitments with its neighbors.

Corruption problems

Corruption has long plagued the Islamic Republic and continues to do so.

In 2013, Total agreed to pay a $398.2 million fine to settle a Foreign Corrupt Practices Act case based on US Securities and Exchange Commission and Justice Department charges of bribery of Iranian officials (OGJ Online, May 30, 2013).

According to documents presented in court, Total intermediaries in 1995 paid a $16 million bribe to Oil Ministry officials for a contract to develop offshore Sirri A and E oil and gas fields. In 1997, several months after Zanganeh was appointed oil minister by reputedly moderate and reformist President Mohammad Khatemi, Total entered a similar arrangement with the Oil Ministry. This time, company intermediaries paid a $44 million bribe to gain a contract to develop two phases of South Pars gas field. The company was awarded 40% interests in those phases of South Pars.

In another well-publicized example, during Zanganeh's first term as oil minister, Statoil in 2006 acknowledged the payment of bribes in 2002 and 2003 to Oil Ministry officials to secure a development contract for part of South Pars gas field. The company paid fines and disgorgements in the US and Norway totaling $21 million and submitted to a 3-year deferred prosecution agreement.

NIOC in 2010 had a contract with Crescent Petroleum Co. to export natural gas to the UAE, but the agreement was abruptly canceled after disclosure of corruption involved in the deal.

Many hurdles

To international observers who have seen "moderate" presidents come and go without moderating Iranian policy and who have heard claims about oil industry capabilities that have proven to be exaggerated if not wholly untrue, the only reasonable approach to the latest signs of change inside Iran is skepticism. With the economy crippled by sanctions, employment at an all-time low, and inflation high, officials of the Islamic Republic have been forced to the negotiating table. Until action supports the words, diplomatic overtures by the new president must be viewed as tactical flexibility, undertaken to mitigate sanctions and buy time to advance development of nuclear weapons covertly.

The interim deal concluded last November on Iran's nuclear program, followed by the Jan. 12 confirmation that the Geneva agreement will be put in action for 6 months starting Jan. 20, 2014, could be the first steps of many that might eventually lead to the full return of Iranian oil and gas to the international market. However, the market has been skeptical that the agreement will survive. Without across-the-board lifting of the international sanctions, there is a slim chance that any major oil company will show interest in investing in Iranian oil and gas.

Considering the diminished capability of the Iranian oil and gas industry, the lack of investment and maintenance, the absence of effective and knowledgeable administrators, and most of all the deep-rooted corruption in the whole governing system, including the oil industry, even if sanctions were lifted, the Islamic Republic would still fail to become a significant gas or even oil exporter quickly.

Even if all sanctions ceased by July 20, 2014, there are still many hurdles to pass before Iranian oil production can rise to the 4 million b/d announced by the oil minister. Are Iranian oil fields mechanically intact despite not being maintained and having low or no productivity? Are oil wells properly and periodically reworked and recompleted? Are effective water-handling and gas-injection operations performed? Are foreign oil companies with capital and modern technology in hand? And most of all, will the Oil Ministry change its habit of falsehood and carry out its duties cleanly and transparently?

The author

Mansour Kashfi, PhD, is president of Kashex International Petroleum Consulting and is a college professor in Dallas. He also is the author of more than 100 articles and books about petroleum geology worldwide. Kashfi holds a BS degree in geology from the University of Tehran, an MS in geology-subsurface stratigraphy from Michigan State University, and a PhD in geology-tectonics and sedimentology from the University of Tennessee. His e-mail address is [email protected].