U.S. sanctions against oil giants at odds with its Caspian policy

Contract workers are expanding Azerbaijan International Operating Co.'s Sangachal crude oil terminal near Baku. The project includes construction of incoming lines and upgrading of the main export lines. The Sangachal onshore terminal is where Azeri/Chirag/Guneshli oil output will be stored for subsequent pipeline shipment to world markets. Photo by Oleg Litvin for AIOC, courtesy Amoco Corp.

Adapted and updated from a paper presented at the International Forum, Nicosia, Cyprus, Apr. 28-30, 1997. The views expressed in this paper are the author's and do not necessarily reflect those of the Centre for Global Energy Studies.

The strongest indirect effects of the current sanctions will be felt in the Caspian region-an area of major international interest and planned development because of its huge potential oil and gas reserves.

The U.S. should consider the full range of effects of its current policy. Particularly important is the ability of world markets to rebound in the event of another oil crisis. In addition, however, is the fact that the policy runs counter to the importance the U.S. places on developing Caspian reserves.

Given the tendency to use sanctions as a tool to protest political systems and human rights issues, the list of countries on which the U.S. imposes sanctions could grow to include, in addition to the recently added Myanmar, countries important to U.S. oil supplies such as Nigeria, Colombia, Egypt, and possibly Saudi Arabia.

It is necessary to ask whether the political objectives of sanctions justify the risks of shortages, price hikes, and energy crises.

Effects of sanctions

More importantly, proved oil reserves in these countries are 230 billion bbl, or 23% of world oil reserves. This shows that their production is low in proportion to their reserves.

This comparison is also an indirect indicator of their future production potential. More direct estimates of future oil supply and demand show that the required oil production from Iran, Iraq, and Libya will be more than 10 million b/d in the next decade. This quantity would constitute 14-15% of world oil supplies at that time.

Although this will be below their collective 23% share of reserves, it is still significant.

Needless to say, the U.S. will not be immune to oil market crises such as the loss of supplies from these countries. Although the U.S. will import oil from other countries, supply shortages and price increases will be universal.

Is barring such a quantity of oil supply from the world market wise, and will political objectives justify such an action?

Perhaps the policy-makers that defend U.S. sanctions hope that, by the time such a loss takes place, major discoveries will have been made outside these three "rogue" states. Furthermore, these supporters probably hope that, through improved technology, production from other countries will be disproportionately higher than their reserves.

They therefore expect that future production in the rest of the world will be higher than forecast and that the world will not need the future production from Iran, Iraq, and Libya.

This is an unlikely scenario. Implicit in this outlook are the assumptions that oil supplies are inexhaustible and that, even under a weak price regime, discoveries will continue to be made and high-cost fields will be brought on stream.

The solid performance of world oil markets since 1990 could be contributing to this overly optimistic view.

In the first few years of this decade, Kuwait had ceased production and, until recently, Iraq's oil was cut off from the world, yet oil prices remained generally weak. This experience may have introduced complacency and a false sense of security.

It should be remembered, however, that in 1990 the shortfalls from Iraq and Kuwait (nearly 5 million b/d) were met by quickly activating spare production capacity in other Organization of Petroleum Exporting Countries (OPEC) states. The most prominent makeup producer was Saudi Arabia, which increased output to about 8.5 million b/d from 5.5 million b/d in the second half of 1990.

Without the availability of a supply cushion in the form of spare production capacity, world oil prices would have risen and remained high for most of the period.

Additions to reserves through new field discoveries, new pool discoveries, and enhanced oil recovery could not meet the growing world oil demand in the coming decades, especially if some of the oil-rich countries in the Middle East are excluded from the market.

Greater cushion needed

The estimate of future production requirements from Iran, Iraq, and Libya mentioned earlier were based on trends in world oil supply and demand and on the factors affecting those trends. But major market disruptions are caused by events such as wars, political turmoil, extreme weather, and technical and nontechnical problems in production or development activities.

It is for such events that greater spare production capacity is needed to prevent oil shortages.

The distribution of this spare production capacity is equally important. Spare capacity should be available in many countries around the world.

At present, about two thirds of the world's spare production capacity is in Saudi Arabia. As a result, the world oil market relies excessively on one country, creating a very risky situation.

Is it hoped that, when such crises arise, sanctions will be lifted, removing barriers to allow the expanded production from Iran, Iraq, and Libya to enter world markets.

Crisis response

Such development projects are large-scale and take many years to plan and implement, even for a field being developed for the first time. For the full development of a nonproducing field, further detailed exploration, 3D seismic surveys, and appraisal drilling and evaluation are needed to understand the extent of the reservoirs and prepare a field-wide plan for optimum production.

In producing fields, troubleshooting and production expansion take even longer.

It should be remembered that the proven reserves in these countries are mostly in fields that have been producing for decades. Increasing production from these fields will be a more complex and time-consuming process.

Furthermore, additional exploration has to be carried out to maintain a sufficient resource base and support future production in these countries. Exploration has a much longer lead time before it bears fruit. It must be started years before the produced oil is required.

Such activities cannot be carried out overnight. And sanctions introduce an unnecessary delay in commencing exploration and development.

On the other hand, without political interference, the international oil industry-including state-owned oil companies-will conduct negotiations, reach agreements, make investments, perform E&D, continue or cease operations, and provide opportunities for their competitors, all as part of the global oil business. In other words, free market forces will function, resulting in a global balance.

The imposition of sanctions introduces undesirable delays and distorts normal market processes. Sooner or later, a supply/demand imbalance will occur-probably an oil shortage. Lifting sanctions and starting operations in Iran, Iraq, and Libya after the advent of supply shortages would not provide a quick remedy for an oil crisis.

A history lesson

The state of the art in oil field technology was employed in these operations through the former partners of Saudi Aramco. But the pace of production expansion was too fast for proper implementation.

Many problems were encountered as a result of hasty development, including a rapid decline in reservoir pressure and the development of free gas in some reservoirs, although only locally and near producing wells. There were also failures in surface facilities, such as pumps and stabilizer plants.

Saudi production had to be cut by 1-2 million b/d on many occasions-some lasting several months-until corrective measures could be taken. Some measures, such as finding injection water supplies, installing surface facilities, and drilling and completing injection wells, required several years to be implemented.

Repeating this experience in another country during the next decade will take much longer and will cause a number of more serious problems. The status of the fields will be even worse if that country's oil industry has suffered from underinvestment and poor maintenance as a result of several years of sanctions. Under these circumstances, rapid increases in production will be next to impossible.

U.S. action against Iran

Some predict negative effects and the impending collapse of Iran's oil and gas industry, while others see no such effect. The exclusion of U.S. companies from purchasing Iranian oil was said to have, by itself, caused hundreds of million dollars in lost revenues for Iran.

Other analysts acknowledge only minor adverse effects. Their argument is that, before the action, U.S. companies purchased only one fifth of Iranian oil exports (500,000 b/d out of 2.5 million b/d) and that securing alternative sales was not a serious marketing problem for National Iranian Oil Co. (NIOC). The measure has, however, reduced the number of supply sources available to U.S. companies and limited their maneuverability compared with non-U.S. competitors.

The effects of secondary sanction threats against non-U.S. companies investing in Iranian oil and gas also are subject to different interpretations.

One side believes these measures have caused oil companies and in- vestors to shy away from Iran's petroleum scene, resulting in a complete failure of Iran's field development plans. Others claim no effect from such measures.

These extreme views stem from an emotional commitment to the sanctions' political objectives, or from strong nationalism, or from a commitment to the Islamic revolution.

Having noted the extreme views, it should be acknowledged that an unbiased analysis is not easy, especially in the absence of factual information and data. Nevertheless, the success of sanctions is questionable, especially in achieving political objectives.

Experience has shown that similar sanctions were unsuccessful in countries such as Cuba, Iraq, and Libya. In the case of Iran, such measures will not result in the overthrow of the Islamic Republic nor in changes in Iranian government policies.

As to their effect on Iran's oil and gas industry, they could neither bring about its collapse nor prevent oil and gas production and exports. This is particularly true because the sanctions are imposed only by the U.S. Others-Canada and European and Asian countries, for example-do not agree with the U.S. policy.

The threat of secondary sanctions resulting from the D'Amato bill has, in fact, caused strong international reactions, raising questions about global free trade and the extra-territorial nature of U.S. statutory decisions (OGJ, Oct. 6, 1997, p. 31).

In the past 2 years, fewer companies have been applying to participate in Iran's oil and gas projects. U.S. companies have been absent, and some others (those concerned about the U.S. threats) have delayed their commitments while evaluating the legal implications.

With fewer participants, it can be assumed that Iran's bargaining power has been diminished, resulting in less favorable terms for Iran.

Similarly, because of the ban on exporting U.S. technical equipment to Iran, its choice of suppliers and manufacturers is more limited, and it must pay higher prices for goods. This is especially true for spare parts in plants and equipment purchased from U.S. companies, and which are now in need of major repairs and maintenance.

Possible outcomes

The second possible outcome is an Organization for Economic Cooperation and Development sanction against Iran, which would enable Iran to continue trade with the former Soviet Union (FSU) and the rest of the world. In this case, the petroleum sector would suffer, and oil production would decline, but Iran's oil and gas industry would somehow survive.

The most likely scenario, however, is rejection of the U.S.-imposed sanctions by the rest of the world. Similar to the Helms-Burton bill for secondary sanctions against Cuba, the D'Amato bill could also result in court cases brought about by the affected companies with the support of their respective governments, or legal proceedings in international courts regarding violations of World Trade Organization rules.

It is also possible that, similar to the Cuban case, a compromise could be reached between European countries and the U.S. Alternatively, European oil companies with less business interest in the U.S. may continue to take part in Iran's oil and gas activities.

Similar to the experience of the past 2 years, under this scenario, Iran's oil production would increase gradually. Costs would be higher, however, because Iran could not purchase oil field equipment and supplies from U.S. manufacturers, and U.S. service companies could not participate.

There would be fewer competitors, and Iran would pay higher prices. Furthermore, some of the latest technologies would not be available. With the participation of some European and Asian companies, however, Iran's oil and gas sector would grow.

It could be speculated that the European Union (EU) does not wish to follow the U.S., particularly because U.S. policies regarding Iran are generally based on U.S. political considerations. In addition, EU member states tend to act independently, and their relations with Iran will remain mostly bilateral, especially on trade.

It is on issues such as human rights and the environment that collective negotiations will take place with Iran.

Thus the last scenario will remain the most likely.

Conoco's exit

That this agreement was reached with a U.S. oil company was not without political implications. One explanation is that the Islamic Republic was clearly differentiating between oil business and politics.

Some political observers, however, attach greater significance to this agreement, interpreting it as a signal for improving relations between Iran and the U.S. It is also believed that, whatever the motivations, this agreement would have been a catalyst for improving the countries' relationship.

Irrespective of its political significance, the Conoco deal made good business sense, and it is regrettable that it was cancelled by President Clinton's executive order in 1995. In addition to being an oil field development project, it was also ideally positioned to supply gas to meet Dubai's requirements.

Dubai's oil production has been declining in the last few years. In order to arrest or delay this decline, or at least reduce its rate, Dubai needs to inject gas into its oil fields, the two most prominent being Fateh and Southwest Fateh in the Persian Gulf.

These fields are virtually adjacent to Iran's offshore Sirri fields. And the development of Sirri A and E was the subject of the Conoco-NIOC agreement.

Associated gas from Sirri is the obvious source for injection into Dubai's oil fields. This use of the gas must have been considered by Conoco when it was negotiating with Iranian authorities.

This is even more likely because Conoco is the operator in the Dubai Petroleum Co. (DPC) partnership. It developed the Fateh and Southwest Fateh fields and has been producing them for many years.

Following the cancellation of the Conoco deal, the French firm Total SA reached an agreement with Iran for development of Sirri A and E fields. The use of gas for Fateh and Southwest Fateh must have been considered by Total also, particularly because it also is a partner in DPC.

Total is developing the Sirri fields. Because of pressure from the U.S., however, Dubai is not going to utilize Sirri gas.

In addition to the need for gas injection in Fateh and Southwest Fateh, gas is also needed to meet the rapidly increasing energy requirements of Dubai in the coming years. This is because of the inevitable decline in Dubai's oil production and its continuing economic growth.

Natural gas is expected to supply most of the future energy needs. Gas from Sirri fields also could have been used for Dubai's onshore requirements, and the project would have made Iran's other fields and its rich natural gas resources available to Dubai. No resource constraints would have prevented supply of gas to Dubai.

It is unfortunate that political pressure appears to be leading Dubai to alternative, costlier sources of gas. And Dubai will have to rely on suppliers with more limited gas resources, and long-distance transportation will be necessary.

The Iran-Caspian connection

The latter goal is especially harmful to the economics of oil and gas developments in the Caspian basin.

Iran's existing network of oil and gas pipelines and related infrastructure provide the lowest-cost outlet for Caspian-area production. It could be estimated, for example, that about 500,000 b/d of pipeline capacity will be available in Iran for transporting oil from north to south. Only minor connecting pipelines would have to be built over short distances to link existing pipelines to border areas.

Construction of additional pipe-lines adjacent to the existing lines would be a simple way to handle future increases in Caspian production. In the more immediate future, the Caspian oil could be used by refineries in northern Iran in return for exports of Iranian oil from the Persian Gulf on behalf of Caspian producers.

Caspian oil therefore will soon reach international markets-by proxy and also physically-because pipeline construction and looping will be carried out in Iran more quickly than in the Caucasus region.

The utilization of the Russian pipeline system has not been a satisfactory experience. Exporting the first oil from the international consortium AIOC to the Black Sea, for example, has been delayed because of protracted negotiations between Russian and Chechnyan authorities and delays in pipeline repair work. A new pipeline that bypasses Chechnya might be built.

Future prospects do not seem bright. In any case, whether through Georgia or Russia, the oil will be delivered to the Black Sea and must be transported to the Mediterranean. These shipments will face the oil tanker congestion and accident risks of the Straits of Bosporus and the Dardanelles.

Turkey has given clear warnings of the risks and has expressed its opposition to increased shipping. The country has said that it will limit the number of tankers passing through the straits.

In addition to the need for transportation through the congested straits, the Caucasus and Russian export alternatives mean that the Mediterranean will become Caspian oil's outlet into world markets. The Mediterranean, however, is a relatively oversupplied region.

On the other hand, there is a rapidly growing demand for oil in the Asian and Far East markets. Thus, by exporting Caspian oil through Iran and the Persian Gulf, the congestion in the straits will be avoided, and the oil from the southern republics of the FSU will have easier access to a preferred international oil market.

Iran provides similar advantages for transporting Caspian natural gas. The need for the construction of high-cost, long gas pipelines could be avoided if the existing Iranian gas network is utilized and later expanded.

Again, for the immediate future and before the pipeline expansion is completed, the gas produced in those republics could be used in the domestic markets of northern Iran. In fact, in spite of political pressures, this scheme is being implemented between Iran and Turkmenistan.

In short, Iran is the geographical key to oil and gas exports from countries around the Caspian Sea and in central Asia. Political pressures aimed at isolating Iran will cause unnecessary delay in world access to these resources, which have only recently been made available to the international oil and gas industry and to foreign investment.

A great deal of emphasis has been put on the Caspian's massive potential. The U.S. has been most outspoken on the importance and international significance of these resources. But the policy to isolate and bypass Iran has created a dilemma for the U.S.

On the one hand, the U.S. wants the newly established republics of the FSU to become truly independent and less reliant on Russia. On the other hand, the U.S. does not want the pipelines exiting these countries to pass through Iran, although this is the most logical route.

The alternative of using the existing Russian pipelines is fraught with operational problems, but, more importantly, it will result in an even greater reliance of these republics on Russia, contrary to U.S. policy goals. Thus there is an inherent contradiction in the U.S. policy that cannot be easily resolved unless the undue insistence on Iran isolation is dropped.

In brief, the efforts aimed at bypassing Iran introduce a major distortion in the future economic development of the oil and gas industry in the Caspian basin, resulting in higher costs for the global industry.

Some recent events have been encouraging, however. The U.S. has agreed to gas export pipelines from Turkmenistan via Iran and Turkey or to swapping oil from the Caspian Sea area for Iranian oil in the Persian Gulf. It is hoped that business considerations will play a greater role in the future.

Sanctions and the oil business

Sanctions have introduced a new element of uncertainty into the world oil scene and increased the risks of international operations. In particular, the U.S. sanctions appear to be ad hoc decisions resulting from collective emotions and domestic political bargaining and altercations.

One gets the impression that imposing oil sanctions has become a negotiating tool between the U.S. administration and the various factions in the legislature, and that it is also strongly influenced by lobbyist power. The last-minute addition of Libya to the Iran sanction bill of Sen. D'Amato suggests that it was the result of such bargaining, rather than of a well-studied preparation for an act of Congress. Libya was not part of the bill in its earlier stages in various House and Senate committees.

It is also extremely worrying to the international oil industry that U.S. sanctions might not be limited to these three countries. Remarks have been heard from the U.S. legislature and political activists naming other oil-producing countries as candidates for future sanctions.

It is becoming a popular foreign policy tool to impose sanctions as soon as a country's behavior is not to the taste of some legislators or pressure groups.

The influence of media appears to discourage House or Senate members from voting against an issue that, at first sight, does not seem to affect the U.S., while supporting the bill will increase the member's popularity. In this way, the names of more and more countries are brought to the front.

Among the issues that could initiate the imposition of U.S. oil sanctions on a country are: the country's political system, the degree to which democracy is observed, human rights issues, delays in succeeding in fighting drug cartels, and the government's foreign policies-especially towards international topics that interest the U.S.

This process creates an open-ended list of countries, which could be expanded to encompass Syria, Nigeria, Colombia, Indonesia, Thailand, Algeria, and Egypt, among others, and possibly even Saudi Arabia. The domestic politics of Saudi Arabia and corruption and human rights issues have sometimes been criticized by U.S. analysts, and the administration has been warned of the extent to which the U.S. is increasing its dependence on the Al Saud royal family.

The adverse effects of these uncertainties hit the U.S. oil industry hardest. The most obvious consequence is losing investment opportunities and operations in areas with prolific oil reserves and high production potential.

This is made even more important by the fact that their non-U.S. competitors are quick to take advantage of these opportunities. In most cases, oil companies from Europe, Asia, and Canada have moved in and have concluded agreements that U.S. companies started with those countries.

In addition to U.S. companies losing the opportunity to sell oil-related equipment and provide services, banning oil purchases from these countries also has adverse effects on integrated U.S. oil companies.

The international units of such companies produce or purchase oil from around the world, transport the crude to refineries in other locations, transport refined products, and finally distribute and sell to final consumers. Numerous sources of crude supplies, refineries, and consumer markets make up the global network of an international oil company.

In a competitive world, each company's network is planned and operated to maximize profits. A greater number of supply sources gives a company more flexibility in planning its operations. On the contrary, when sanctions remove some of these supply sources, the company's flexibility is limited, and it will be at a disadvantage compared with its international competitors.

Politics in the oil industry

Although the Arab oil embargo occurred almost a quarter of a century ago, it is worth remembering some pertinent points. The embargo was imposed not by OPEC but by Arab countries, although some of them were OPEC members.

They imposed the embargo during the Arab-Israeli war. It was not a global embargo but a reprisal against only four countries supporting the Israeli war effort.

The embargo was introduced gradually and was lifted a few months later. Unfortunately, a misunderstanding has persisted in the media, blaming OPEC for the embargo.

OPEC has been wrongly criticized by journalists, commentators, politicians, and speakers at conferences and seminars, who claim that OPEC mixed politics with the oil business. It is unfortunate that this wrong perception persists.

Similar criticisms have been directed at countries that nationalized their oil industries in the 1960s and 1970s. Even though these actions were recognized as legitimate conduct by sovereign states against the excesses of the old concession system and were supported by various international courts, the criticism has continued, again directed at political interference in oil business.

It is therefore ironic that the imposition of oil sanctions has today become a common feature of U.S. foreign policy.

Shouldn't the critics of the Arab oil embargo now turn their attention to the U.S. sanctions policy? Don't observers of the world oil scene notice a contradiction between the well-publicized illegitimacy of political interference in oil business in the 1960s and '70s and its unquestioned legitimacy today?

The Author

Manouchehr Takin is a senior petroleum upstream analyst with London's Centre for Global Energy Studies. Before joining CGES in 1990, he spent 9 years as a senior research officer at the OPEC Secretariat, analyzing global energy and oil markets. He has 16 years of experience in the oil industry, and served as acting head of exploration/production research at National Iranian Oil Co. and as exploration manager with the former Ultramar Corp. He has a BS Honors degree in geology from Manchester University, an MBA from the Industrial Management Institute, Tehran, and a PhD in geophysics from Cambridge University.

Copyright 1997 Oil & Gas Journal. All Rights Reserved.