Sara Vakhshouri
SVB Energy International
Washington, DC
For an oil market destabilized by geopolitical turbulence and oversupply, an important question is when Iranian production, now limited by international sanctions, might recover and rise toward the Islamic Republic's geologic potential. The question gains importance this month, by the end of which officials of Iran and the five permanent members of the United Nations Security Council plus Germany are to have concluded an agreement on Iranian development of nuclear weapons. Because Iranian negotiators have made ending the sanctions against it a priority, the possibility of a surge in exports from the country looms over the market.
Yet a combination of factors complicates the ability of Iran to bring large new supply quickly to the market. Sanctions on oil exports are not the only impediment. The country also must solve technical problems, grapple with international sanctions on investment, and regain lost market share.
Production capacity
Iran's mature oil fields are in advanced stages of decline. The US Energy Information Administration estimates that Iranian oil fields have natural decline rates of 8-11% and recovery rates of 20-25%.
Iran had planned to employ water and gas injection for enhanced oil recovery. Gas injection in mature field was to have reached 330 million cu m/day by the end of 2016. Since 2011, however, Iran hasn't been able to reach more than 60% of its gas-injection goals. The average of actual gas injected between March 2006 and March 2011 never increased more than 75% of what was originally planned.
Iran's fifth 5-year plan, covering March 2011 to March 2016, called for $155 billion of investment in upstream oil and gas for development of existing and new fields, aimed at boosting production to 5.152 million b/d. But international sanctions thwarted the plans.
General mismanagement and vagaries in investment priorities also hampered the effort to raise production capacity during the administration of President Mahmoud Ahmadinejad. Now, Iran's financial resources are squeezed by sanctions and low oil prices.
Sanctions against the Iranian energy industry after 2010 have limited the country's access to foreign technology, capital, and oil-field equipment and services. The post-2010 sanctions regime has proven far more damaging than anything passed before.
Because of sanctions, for example, Iran has had a hard time hiring or purchasing the drilling rigs it needs to boost production.
After the European Union-imposed embargos on exports and shipping insurance in 2012, Iranian oil exports fell to almost half their level of a year earlier, forcing National Iranian Oil Co. (NIOC) to cut production and shut down some of its fields. The cuts of course focused on very mature, inefficient fields and wells, especially those producing heavy and extra-heavy crude oil.
In all, Iran's production and production capacity have been hammered. Since Iran cannot produce crude oil at maximum potential rates, and because it has had to halt production from some of its older fields, analysts cannot precisely estimate Iran's production capacity. Estimating potential recovery from idle fields would be guesswork.
The Iranian oil ministry estimates the country's crude oil production capacity at 3.5-3.7 million b/d. With condensate considered to be light crude oil, production capacity rises to perhaps 4 million b/d.
Production rebound
Aside from real uncertainties about oil production capacity, Iran's ability to increase production in case of sanctions relief is another major question. If sanctions are lifted, how much and for how long will it take Iran to increase its production?
Oil Minister Bijan Zangeneh announced that Iran's production could increase by up to 1 million b/d quickly. The International Energy Agency estimates that Iran's production capacity is 3.6 million b/d and that the country can increase output by 600,000-800,000 b/d within 3 months. In May, the IEA reported Iranian production in April of 2.88 million b/d, up 90,000 b/d from March.
Two main uncertainties hamper predictions about Iran's oil production rebound. The first is Iran's technical ability to raise output. The second is the country's ability to export oil.
Some observers argue that production cuts in old fields have enabled reservoir pressures to increase and might allow production to resume at high rates. Gas injection also might boost output in mature fields within 3-6 months.
Iran's condensate production is increasing along with production of natural gas. Gains followed completion a few months ago of several development phases at giant offshore South Pars field, including phases 12, 15-16, and 17-18, which added 120,000 b/d of condensate ready for export. Most of the condensate is being stored at sea, occupying two thirds of Iran's current floating capacity and awaiting a buyer. Iran's condensate production is expected rise even further in 2016.
It is thus conceivable that Iran can raise its crude oil production about 500,000-700,000 b/d within 3 months, and up to 800,000 b/d within 6 months.
But the other question, access to the market, remains unanswered. The sanctions target Iranian exports. It might take at least 3-6 months from the time of a nuclear agreement for sanctions to be lifted significantly. And removal of the ban on imports of Iranian oil in Europe requires a consensus of EU members. This might be hard to achieve quickly.
There is no doubt that any nuclear deal will have an immediate psychological effect on the market. Sales negotiations will start, and Iran at least could slightly increase its crude oil and condensate exports, particularly by the last quarter of this year when a seasonal demand increase in Iran would absorb some of the incremental production.
Regaining market share
Beyond sanctions, Iran's other challenge for raising its oil exports is regaining lost market share. This problem is particularly acute at a time of oversupply and low oil prices.
Most of Iran's competitors supplying similar crude oil to the same markets, mainly Saudi Arabia and Kuwait, have secured their sales by signing term agreement with customers. These commitments are usually for at least 1 year.
So Tehran has no choice other than to sell most of its oil in the spot market for the next year. It will have to create incentives for signing term contracts to regain long-term market share. Since Iran lacks a huge capacity to store unsold oil, it could increase crude oil production only slowly and cautiously. With prices low, it doesn't make sense for Iran to rent tankers as floating storage and sell oil at further discounts. Oil stored at sea will encourage Iran's customers to push for further discounts.
The outlook for Iranian condensate is different. High in sulfur, Iran's condensate is considered a light crude and is traded at prices higher than those of its heavy oil. Iran has fewer competitors for condensate-for which demand, particularly in Asia, is high-than for oil.
Condensate flow will increase with gas production, particularly from South Pars field, an extension of Qatar's supergiant North field. The field has been Zangeneh's highest priority for development.
Condensate makes up much of the 30 million bbl of oil Iran currently holds in floating storage, which will provide the first cargos ready for immediate export when sanctions are lifted. This offloading would reduce rental costs while Iran prepared to boost production. Therefore, we can expect an immediate release of oil from floating storage upon any possible deal at the end of June or in early July.
If negotiations lead to a comprehensive deal on Iran's nuclear program by the end of June or early July, Iranian production and exports will rise about 200,000 b/d by the end of 2015 because at least some of the sanctions might then have been eased and because global demand will be seasonally high. The rest of the country's production and export increase would enter the market gradually through mid-2016.
An open question is how extra Iranian supply would affect the global oil market. While predictions vary for production from shales and other low-permeability formations in 2016, most analysts expect low oil prices at least to suppress growth rates from these sources if not to cause declines in the next year or two. Decline forecasts have been as high as 1 million b/d of so-called tight oil.
A gradual rise of crude and condensate from Iran thus might be offset by a decline from shale next year and have a modest impact on the price of oil. That balance, of course, has a broader geopolitical context as crises in Yemen and Iraq keep upward pressure on the crude price.
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