Tehran’s former oil minister Masoud Mirkazemi issued a stark warning in May 2010. Typical of an Iranian minister, he denied that the country’s increasing international isolation and enhanced sanctions were affecting the country’s oil sector. But he warned the hydrocarbons sector requires investment worth $150bn-200bn over the next five to six years to arrest declining production rates. A lot is at stake, Iran risks becoming a net oil importer if output rates continue to fall.

Iran is struggling with a shortage of project finance, technology and skilled personnel

As Opec’s second largest producer and exporter, Mirkazemi’s warning might sound alarmist. It could also be self-serving. The projection could be a bureaucratic trick by the Oil Ministry to scare parliament and the budget office into raising the ministry’s budget. Nevertheless, the oil minister is not alone in warning that Iran is on course for a meltdown in the energy sector.

Mature oil fields

Much of Iran’s production comes from mature fields, some of which have been producing since the 1950s or longer. The country has been forced to use enhanced oil recovery (EOR) techniques to arrest a decline, as well as to develop new discoveries to replace production. Conservative estimates suggest Iran needs to replace at least 300,000 barrels a day (b/d) of oil production a year as its fields mature.

So far, Tehran has managed to do this, maintaining average production capacity above 3.5 million b/d over the past decade and more than 4 million b/d since 2003.

In 2010, production totalled 4.2 million b/d, up 46,000 b/d from 2009, an increase of 1.1 per cent. Opec quotas currently limit exports to 3.6 million b/d. Nonetheless, output is far lower than it was 30 years ago. On the eve of the Islamic Revolution in 1979, Iran produced more than 5 million b/d of oil.

Four giant fields, Agha-Jari, Gach Saran, Ahwaz and Marun produced more than 1 million b/d each. But pressure has fallen at these fields and they are now producing at much lower rates. Many have horizontal wells to tap into the fracture systems, which contain most of the oil. The natural rate of decline in Iran’s crude oil production is estimated at 8-11 per cent a year.

Importing advanced EOR technologies to halt the decline in production has been difficult due to international sanctions and high costs. Iran depends on older methods to maintain recovery from its mature oil fields, such as injecting massive quantities of natural gas into its reservoirs.

Against the backdrop of rising domestic demand and a lack of foreign investors, Iran’s ambitious targets of lifting production from 4.1 million b/d to 5 million b/d over the long term have been missed and pushed back. This was the case even before foreign investment in Iran started drying up.

Technology constraints in Iran

Iran is struggling with a shortage of project finance, technology and skilled personnel. Tehran is also finding it harder to secure both onshore and offshore rigs for exploration and development programmes, and the lack of technology often hampers production facilities.

According to London-based energy consultancy IHS Global Insight, Iran’s onshore rigs have low operational reliability. It also struggles to drill more advanced wells for EOR projects and to reach deeper geological horizons, while outdated gas injection technologies are inefficient.

With its option limited, Iran has had to focus on fewer projects, prioritising exploiting oil and gas fields owned jointly with its neighbours the UAE, Iraq, Kuwait and Oman.

Conventional methods can on average only produce 20 per cent of the oil in place before the natural pressure of the field decreases. By 2015, crude oil production is expected to fall to 3.8 million b/d from 4.2 million b/d in 2010. Production capacity could fall faster if sanctions continue. The worst case scenario sees output dropping to 3.3 million b/d by 2015. According to Honolulu-based energy consultants Facts Global Energy (FGE), condensate production in Iran is increasing as more phases of the South Pars gas field come onstream. This goes someway to explaining why Iran’s liquid production has remained stable, despite a lack of investment.

“Of all the techniques, Iran’s oil fields are sensitive to gas injection,” says Morteza Ghashghai, managing director of Tehran-based engineering consultants, Namvaran SimTech. 

Gas injection for Iran’s oil fields

Iran plans to double the amount of gas injected into its oil fields by 2015. Gas injection into Iran’s 15 oil fields is due to rise to 360 million cubic metres a day (cm/d) under the oil ministry’s five-year plan.

As much as 250 million cm/d will be used in the country’s southern fields. Iran is already implementing new gas injection techniques in some fields, replacing water injection methods.

According to Deputy Oil Minister Mohsen Khojasteh-Mehr, the Oil Ministry is obliged to allocate 10 per cent of the country’s export receipts to the protection of oil reservoirs. “Any reduction in extraction from joint field is, in effect, considered as a waste of reserves,” Mehr says.

Analysts warn that even this may not be enough to halt Iran’s natural decline in oil production. A further challenge facing Iran is the lack of financial resources. Projects are also frequently delayed due to the lack of access to experienced contractors, who can finish projects on time.

Then there is the enormous domestic need for gas. In 2008, roughly 70 per cent of Iran’s gas was marketed, 16 per cent was used for EOR, while flaring accounted for about 14 per cent. Last year, gas production climbed 5.6 per cent to 138.5 billion cubic metres from 131.2 billion cubic metres in 2009.

In 2009, Iran inaugurated its largest EOR scheme at the Agha-Jari oil field in southwest of the country. The scheme cost $300m and it involves injecting 2 billion cubic feet a day of gas from the South Pars field to produce 5,000 b/d of oil. The field holds about 10 billion barrels of oil and is projected to produce 2.1 billion barrels over a 25-year timeframe.

In five years, Iran will require 360 million cm/d of gas for reinjection. It currently uses 90 million cm/d, according to Mohammad Ali Emadi, managing director of research and technology at state-owned National Iranian Oil Company (NIOC).

Emadi says that Iran must establish a medium-to-long term gas balance as the basis for its natural gas policy. This would establish how much gas is used for exports, domestic consumption and for EOR. The Oil Ministry must then prioritise its mature fields, managing its field portfolio on the basis of cost and potential for EOR techniques, as well as looking to other solutions, such as the injection of nitrogen and carbon dioxide.

“A primary study of improved oil recovery methods on different types of Iranian fields proved that there is no unique method regarding the discrepancies of reservoirs, and the classification and ranking of reservoirs should be applied prior to any study,” says Emadi.

But the current development plans are not sufficient to increase oil capacity significantly. It will be a challenge to maintain production at current levels.

Geology is not the only problem. Iran’s constitution commits the country to state ownership of its natural resources and industries, explicitly forbidding the “granting of concessions to foreigners”.

In the oil sector, Tehran has used buy-back agreements where international oil companies (IOCs) can explore and develop oil fields operated by NIOC. They can also bid for the right to become a contractor to the state firm.

Under the agreements, the contractor funds all investments and receives remuneration from NIOC in the form of an allocated production share. It transfers the operation of the field to NIOC when the contract expires.

The contracts have proven unpopular with IOCs who complain the returns, typically 18-20 per cent, fail to cover rising project costs. On the other side, NIOC has to bear the risk when oil prices are low.

Not only are they unattractive, they also hinder sustainable production as fields mature. By the time reservoir pressure drops, the buy-back agreement would have expired and NIOC is left to struggle with maintaining output through gas injection.

“The current buy-back arrangements should be modified to include incentives for long-term planning and improved oil recovery over the life cycle of the field,” says Emadi.

“Service contracts should be designed and deployed to ensure shared incentives for partners involved in the operations and to maximise the exchange of technology.”

China support

Changing the constitution to make the terms more amenable to investors is unlikely. Instead Tehran hopes that China will be willing to take on an increasingly large share of Iran’s oil and gas development. As well as being China’s third largest supplier of crude oil, with about 426,000 b/d of crude oil shipped 2010, Iran is stepping up plans to attract further Chinese investments by offering more attractive buy-back terms.

According to FGE, China National Petroleum Corporation’s (CNPC) terms at the Azadegan field and Sinopec’s at Yadavaran are more flexible than usual, with shorter payback periods and higher rates of return than previous contracts. CNPC has dealt with its own domestic mature fields and this experience will be important for Iran. CNPC is also experienced in heavy oil production, a useful skill for Iran’s ageing reservoirs.

A full deal has remained elusive due to international sanctions. But CNPC is preparing to award engineering, procurement and construction contracts for the North Azadegan field.

Despite three decades of sanctions, Iran remains a key oil producing country. It has vast untapped natural gas resources and continues to prioritise oil production as it provides its most secure revenue source. For many in Tehran, no matter how much its international relations may deteriorate, crude oil is the last commodity that will fall under international sanctions. Unless Tehran is able to look after its maturing oil fields efficiently it may find output is curtailed regardless.