With the largest reserves of gas and the fourth largest reserves of oil worldwide, Iran is a potential pot of gold for oil & gas companies. Foreign private and national oil companies are looking to invest in the Islamic Republic, thanks to the landmark nuclear deal with the major powers and investment terms offered by the Iranian Government. With the new Iran Petroleum Contract (IPC), the Government is trying to increase the country’s attractiveness to foreign investment, in order to revive its oil & gas industry and boost lucrative exports.
Effects of recent sanctions
International sanctions have thwarted the development across Iran’s energy sector, especially upsetting upstream investment in both oil and natural gas projects. Iranian oil production has declined substantially, and natural gas production growth has been more sluggish than anticipated, despite its strong reserves base. The sanctions have resulted in a number of cancellations and suspension of upstream projects. The sanctions impeded Iran’s ability to sell crude oil and cut exports from a peak of 2.5 million b/d before 2011 to just over 1 million b/d in recent years.
According to the International Monetary Fund (IMF), Iran’s oil and natural gas export revenue was $118 billion in the 2011 (ending March 20, 2012). The IMF estimated that Iran’s oil and natural gas export revenue fell to $55 billion in 2014, which was a drop of 53% from 2011 and 2014. The revenue loss is attributed to the sharp decline in the volume of oil exports from 2011 to 2013.
Iran is close to pre-sanction production level
Iran’s oil production levels were relatively flat during its energy sanction period (2013-2015) and averaged around 3.2 million barrels per day (b/d). After sanctions were eased, Iranian oil production rebounded much faster than anticipated as shown by the above chart. At present, Iran is roughly back to pre-sanctions production levels of 4.1-4.2 million b/d. The oil production in the month of August 2016 was 3.6 million b/d. According to the Iranian Oil Minister Bijan Zanganeh, Iranian crude output would reach 4 million b/d by March 2017. JP Morgan bank’s analysts commented that the steep increase in production is possibly a part of condensate volumes being blended into the crude streams and an increase in gas injection into key oil fields as a part of Enhanced Oil Recovery (EOR) techniques. The oil production is forecasted to be 4.8 million b/d by end of this decade, provided that sufficient investment is poured in the oil industry.
Iran is shipping out way more oil
Given the world market is currently adequately supplied; Iran is offering favorable terms, such as credit windows and discounts in pricing to secure long term buyers. Iran restarted negotiations to win back its traditional customers in Europe and Asia and managed to gird many of them for resuming purchase of Iran’s crude oil. Consequently, Iran doubled its oil exports from early 2016. It exported ~2.3 million b/d of crude oil in August 2016. The export strength has been driven by drawing down onshore stockpiles and increased production.
Iran’s top destinations include China, India, Japan and South Korea. Asian oil importers have requested an increase in their oil purchase from Iran. Four major Asian buyers shipped in 1.6 million b/d of Iranian oil in July, which was 1 million b/d a year ago, a jump of 61%. The below table show Asia’s Iran crude imports in thousand b/d for July 2015 and 2016.
France’s giant Total signed a contract for buying 160 thousand b/d of crude oil from Iran. Furthermore, negotiations were held with Russia’s Lukoil and Spain’s Cepsa, ending in the signature of agreements. Greece’s Hellenic Petroleum also started receiving Iran’s crude oil. Iran is estimated to reap $21billion from oil exports this year if the country’s export averages 1.7 million b/d.
Bye-bye to buyback, let’s welcome IPC
The Iran’s Ministry of Petroleum (MoP) has approved new Iran Petroleum Contract (IPC) which is set to replace the prevailing buyback contracts (subject to approval by parliament) to attract International Oil Companies (IOCs) and service industries. In the buyback contracts, pay-back period is shorter than those of present production sharing agreements; typically between 5 to 7 years. Foreign companies are less authoritative on how to manage reservoir development and oil field production and all the power lies with Iranian state owned companies. The IPC model will address much of this criticism.
For instance, it will offer lengthier contract periods of 20-25 years, allowing for much longer cost recovery after first production. The IPC model will allow establishment of a joint venture between Iranian and foreign companies for field exploration, appraisal and development. There will also be a provision to extend into EOR phases.
On paper, this new model will bring reasonable distribution of reward and risk between the Iranian and international firms. Most importantly, technology transfer and the dissemination of technical know-how will start coming back into the country after decades of isolation. These structural reforms are necessary to modernize Iran’s ageing oil & gas infrastructure. The IPC is the framework for 49 upstream oil & gas contracts expected to be signed with foreign investors in coming months.
Several shortfalls of the Iranian buybacks contracts are addressed, however, booking of reserves is still a red-line. Furthermore, it is imperative to note that dispute resolution mechanism under the IPC will be subject to the exclusive jurisdiction of the Iranian courts and many IOCs will prefer international arbitration.
Getting gas out of Iran
Nonetheless, international sanctions have also affected Iranian natural gas sector. But now Iran hopes to increase natural gas production and wants to make a splash on the international gas export market. Iran is ramping up production fast and is expected to produce about 250 bcm of gas by 2018. This additional supply will come from the South Pars gas field which Iran shares with Qatar and holds almost 40% of Iran’s proved natural gas reserves. Beyond 2018, there are already plans for many more phases of development, both at South Pars and other fields such as North Pars and Kish. However, huge capital investment is required for developing gas fields means Iran’s future as a major natural gas exporter is several years away.
Currently, Iran contributes just 1% to the total global natural gas trade, with almost 93% of exports going to Turkey. Iran plans to broaden its gas exports to regional countries as well as to Europe and Asia. It is preparing to triple gas exports to Armenia and start exports to Georgia. It has already started holding talks with Turkey in order to increase the gas export. Further, Iran will start exporting 7 mcm/d of piped gas to Iraq starting from October this year. A second route to Basra will be opened in 2017, with volume eventually reaching 70 mcm/d. Discussions are underway with India to develop Chabahar-Gujarat undersea gas pipeline and Farzad-B gas field. It is also in an advanced stage of technical dialogues with Oman to pipe natural gas to the sultanate through the Persian Gulf.
Iran is also looking for a contractor to resume building the Iran LNG project, which was half complete when it was stalled by western sanctions. With an already oversupplied LNG market, Iran’s goal to start LNG shipments by 2018 is dubious, post-2020 is somewhat realistic and may target China, India, Pakistan, Kuwait, and UAE for Iran’s gas.
Iran: The new investment frontier
Iran is looking to attract an eye-popping amount of $185-200 billion of investment to its upstream and downstream sectors under a five-year development plan that is set to conclude in March 2021. Iran has 27 oil & gas reserves which it jointly shares with its neighbors such as Iraq and Qatar. The shared fields roughly account for 30% of the country’s gas reserves as well as 20% of its oil reserves. Hence, the country’s priority is the development of the shared fields which includes South Azadegan oil field, offshore Farzad B gas field, phase 11 of the South Pars gas field and the South Pars oil layer. To complement the developments and expected investment of $85 billion in upstream sector, Iran has ambitious plans to revolutionize the downstream industry. To accommodate the current growing domestic demands, Iran has to rely on imports of higher value-added refined products, such as gasoline, jet fuel and diesel. Accordingly, Iran has devised a plan to increase its existing refining capacity from 1.86 million b/d to 3.20 million b/d by 2020. In order to cater to the growing demands, an investment of about $26 billion is required to upgrade the existing ten refineries and build five new refineries.
There are also plans to boost output of the petrochemical industry by construction of around 70 petrochemical plants which would require an investment of $80 billion by 2025. Several of the above petrochemical projects have been confirmed, and others are undergoing negotiation. Haldor Topsoe, Danish catalyst and process technology company is setting up an office in Iran and is planning a new methanol plant in Chabahar, southern Iran region. German chemical giant BASF and Linde, as well as Japan’s Mitsui Chemicals are also interested in investing in petrochemical facilities in Assaluyeh (southern Iran). This site is part of the Pars Special Economic Energy Zone (PSEEZ) which will reside a huge petrochemical complex, currently under development, close to one of the biggest gas fields in the world. Another, Danish Company, Novo Nordisk has committed to build a manufacturing plant in Iran. Furthermore, National Petroleum Company (NPC) is in talks with France’s Air Liquide to build a methanol-to-propylene plant in the country. This will place Iran in the league of major petrochemical suppliers and allow it to compete with countries like Saudi Arabia and India.
Rejuvenation of the oil & gas industry in the aftermath of the nuclear deal will be Tehran’s prime priority in the short term which will lead to liberalization of trade and direct foreign investment. As a result, the Iranian economy may grow quickly, driven by exports of oil, gas, petrochemicals and other manufactured goods. This will re-energize the oil & gas industry, thereby generating more growth synergies for other dominant industries in Iran including, marine & logistics, cement, and service.
Game of barrel
Iran is one of the world’s cheapest places to tap new oil fields and pump from existing wells. It costs around $12-13 to produce a barrel of crude oil. While the economics appear to be eye-catching, the margins have narrowed with crude oil price hovering around $47 a barrel when compared with those triple digit price in early 2014. The question now is – is the prize big enough? Low oil prices and narrow margins could one of the reasons why oil giants may shy away from investing in Iran. Much will depend on the contract terms offered by Tehran to international oil & gas companies.
After international sanctions were implemented on Iran, oil states started a race to gain some of Iran’s share. A larger part of it went to Saudi Arabia which enjoyed a substantial surplus in production capacity. Now, Iran is pledging to ramp up production from existing fields, seeking to recoup its market share post-sanction. Consequently, Tehran has ruled out any production freeze at this stage, despite the glut and calls from other OPEC members to curb output as they struggle with lower oil export revenues. A price war has started between the oil nations. Saudi Arabia and Iran are offering discounts to the buyers, signaling that both oil states have no plans to back down. Both the oil nations are entangled in a web of trouble, which may lead to a heavier gravity force on the multi-year low oil prices. Steady oil production growth is also expected from Iraq and Russia. Although, OPEC countries meeting held in Algiers recently agreed to cut output to 32.5 to 33 million b/d from around 33.5 million b/d. However, OPEC didn’t reveal the details of the plan leaving no final agreement date, new production quotas for member countries and periods of the cut. This is expected to be made clear in OPEC November meeting. On the one hand, this deal could balance the market to an extent where the oil price will rise, but on the other hand it could also lead to a surge in non-OPEC oil production, putting pressure again on oil prices. Taking all these factors into consideration, any addition to supply without an equivalent increase in demand will result in a softer market and will delay the true oil price recovery anytime soon.
True, plenty of challenges ahead
Sanctions relief paved the way for Iran’s re-entry into the world oil & gas market. Iranian President and his oil minister, have come up with a master plan to persuade international companies to invest in its ailing hydrocarbon industry by offering them more lucrative contracts. However, several barriers to entry remain for investors, notably, the US continues to enforce bilateral sanctions against Iran and engaging in financial transactions with the financial institutions of Iran is still prohibited. Accordingly, foreign banks are adopting an alert approach to process Iranian payments. Under the Joint Comprehensive Plan of Action (JCPOA), Iran’s nuclear-related activities will also be monitored for the period of next 15 years with the potential for sanctions being re-imposed if the Government do not comply with the nuclear agreement. ‘Snapback’ or the automatic re-imposition of sanctions is the biggest fear of investors. As a result, Western and Asian companies continue to be cautious dealing with Iran, fetching fewer deals than anticipated. With oil & gas companies cutting spending due to the current climate of flat oil prices and surplus production, many companies may not be interested in investing in the country. From the political angle, Iran is about to enter into an election cycle; if President Hassan Rouhani is not re-elected then there is no guarantee that his successor will remain on the path of energy reform. Hardliners are also opposing the IPC framework, citing that, it is offering too much control of Iranian oil & gas assets to foreign companies. It is again a challenging task to satiate both, the hardliners and the IOCs. Iran has a cumbersome past, hence, difficult to make predictions. But being optimistic here, Iran is bracing itself to re-enter in the oil & gas industry with a reinvigorated force.