Iran's economic headache

25 September 2009

Declining oil revenues rather than UN sanctions are the biggest barriers to economic revival

Iran’s President Mahmoud Ahmadinejad had a difficult task in persuading the country’s Majlis (parliament) to approve his choice of cabinet ministers following the disputed June presidential election. But the challenge now facing one of those ministers, Masoud Mirkazemi, appears far greater.

The Majlis voted in favour of Mirkazemi’s appointment as oil minister by a narrow margin in early September. The former commerce minister has no experience of the oil and gas industries, however, and critics in parliament have questioned whether he is the right person to lead the country’s troubled energy sector.

The stakes could hardly be higher. Iran remains overwhelmingly reliant on its hydrocarbons income – it exports 2.3 million barrels a day (b/d) of oil, which provides 80 per cent of the state’s foreign currency earnings. Yet billions of dollars are required each year just to maintain its ageing oil and gas infrastructure.

Since his appointment, Mirkazemi has said $190bn is needed, including $140bn for upstream oil projects and a further $50bn for downstream facilities, over the next five years. If that spending goes ahead, Mirkazemi says Iran could boost total oil production to 5.1 million barrels a day (b/d) by 2014, from 4.3 million b/d currently.

He will find out how realistic such figures are when the government sets out its five-year development plan to 2014 in the coming days, but his ministry is likely to be given far less. Under a draft five-year plan released on 14 September by the Presidential Office for Strategic Planning & Supervision, investment in the oil and gas sector will total $20bn a year, and about 20 per cent of total oil revenues will be deposited in a new national development fund. That leaves a shortfall of about $90bn over the five-year period. Finding that money represents the most pressing challenge for Mirkazemi.

Almost all US and European energy majors have stopped investing in Iran and many international banks have stopped lending, either because of sanctions or the fear of damaging their reputation in Western markets.

To offset this, Iran has turned to Asia. Chinese firms in particular hold few reservations about investing in the Islamic Republic.

China National Petroleum Corporation signed a $4.7bn deal in June for phase 11 of the South Pars gas field development, and China National Offshore Oil Corporation is investing in a North Pars gas structure. Malaysia’s Petronas and India’s Oil & Natural Gas Corporation are also in talks for billion-dollar upstream oil and gas investments.

Funding gap

“These are good sums and good companies but much more is needed,” says one former planning official with the state-run National Iranian Oil Company. “There will be little chance of gas export projects proceeding unless more is committed.”

Analysts estimate that at least $50bn is needed just to complete the 28 phases of development at the South Pars field in the Gulf. And Iran would also like to develop other potential reserves in the Caspian Sea and elsewhere.

Mirkazemi’s predecessor at the oil ministry, Gholamhossein Nozari, tried to fill the funding gap by announcing plans on 31 May to issue $12bn worth of bonds to finance field development. But the bond issue has yet to make progress, and analysts argue that any plan by Mirkazemi to attract such sums in the current climate will also fail. Instead, some projects will have to be scaled back.

“There are simply no capabilities or funds to proceed with all projects on the table at this point,” says Samuel Ciszuk, Middle East energy analyst at US consultant IHS Global Insight.

He argues that increasing Iran’s oil output, or at least preventing a decline in output, will eat up the bulk of the country’s available funds, and plans for gas exports or petrochemicals schemes will have to move down the priority list.

“Protecting the oil revenue levels is easier than establishing gas export capacities in the current situation,” says Ciszuk. “Oil is also the commodity whose exports would be hardest to stop by international sanctions.”

Revamping the country’s 11 refineries is also a matter of urgency. The poor state of the ageing facilities means Tehran currently has to import up to 40 per cent of its petrol to meet domestic demand.

The US and Europe have suggested widening international sanctions to include these petrol imports if no progress is made on talks over Iran’s nuclear ambitions. Ahmadinejad responded on 15 September by urging the oil ministry to build refineries more quickly, but this will not be easy.

“We need skilled foreign companies to refresh the downstream sector,” says the NIOC source. “Our refineries will be a problem until we can lure more foreign investment.”

The problems in Iran’s oil industry are a serious concern for the wider economy, as its revenues are one of the few means by which Iran could potentially earn enough to pay for all the other economic developments required. In particular, the government needs to find a way to create up to 1 million jobs each year to cater for new entrants to the workforce. The official unemployment rate is 11 per cent, but among young people it is estimated to be well beyond 20 per cent.

“The Iranian economy is in a shambles,” said Abbas Milani, director of Iranian Studies at Stanford University, speaking at the Royal Institute of International Affairs in London on 15 September. “The economy has to create about 1 million jobs a year simply to keep unemployment at the current double-digit level. The future for this regime in the economic sense looks bleak.”

Without creating jobs, the government risks opposition to the regime gathering momentum. Despite expectations that protests would quickly whither away after the disputed presidential election on 12 June, opponents of Ahmadinejad have repeatedly taken to the streets in large numbers since then – most recently on 18 September.

“There is a possibility that [the regime] might find stability and become consolidated again,” said Milani. “I strongly doubt that. My belief is that the status quo is untenable.”

Other economic problems persist. The official inflation rate was still at more than 20 per cent at the end of August, according to the Central Bank of Iran. But privately, local economists claim it is significantly higher than that.

The threat of further sanctions – whether against the oil industry or other sectors – is likely to hinder the prospects for international investment even more and will make the government’s task of managing inflation and unemployment even tougher.

US President Barack Obama said in May that his admin-i-stration would push for more wide-ranging trade embargoes on the regime if no progress has been made on ending Iran’s controversial nuclear research activities by the end of the year.

Apparently alive to this threat, Tehran has agreed to fresh talks over its nuclear programme with the five permanent members of the UN Security Council – China, France, Russia, the UK and the US – as well as Germany. Talks are due to start on 1 October.

Energy revivalHowever, there is widespread scepticism about the regime’s willingness to voluntarily abandon its nuclear ambitions.

“I think it would be a grave mistake for the West to take this new [nuclear] offer seriously,” said Milani. “I can guarantee you if this regime makes that promise [to suspend the nuclear programme] it will break it. This regime considers lying to the West its spiritual duty.”

Whether further sanctions will have any significant impact on Iran’s nuclear programme is equally disputed, particularly when Russia and China are likely to oppose any co-ordinated effort by the UN.

But the West has few other options at its disposal, short of military action. Finding ways to undermine the Ahmadinejad regime and support the opposition groups within Iran is fraught with difficulties, as any explicit support is liable to be used against the regime’s opponents as evidence of treason.

“It is almost impossible to find things to do that help, that do not cause harm to the people you are trying to help,” says Sir Richard Dalton, a UK ambassador to Iran from 2002-06.

Tehran probably feels that it can cope with further sanctions, but the difficulties facing its oil industry are potentially far more serious, as that is the source of so much government revenue.

Unless Mirkazemi can find a way to revive the country’s energy sector, the gov-ernment may find that declining oil revenues do far more damage to its ambitions than any sanctions.

Masoud Mirkazemi

Masoud Mirkazemi, Iran’s new oil minister and a firm ally of President Mahmoud Ahmadinejad, has held several senior defence and commerce positions in his 30-year political career, but lacks any experience in the oil sector.

He became a member of the revolutionary committees at the time of the Islamic revolution in 1979 and later joined the Iranian Revolutionary Guards Corp.

During the Iran-Iraq war in the 1980s, Mirkazemi moved into technical planning and support for the Revolutionary Guards.

He became head of research and logistics at the Defence Ministry in 2000, and later a ministerial adviser.

He served as commerce minister during Ahmadinejad’s first term as president, surviving an attempt by members of the Majlis (parliament) to impeach him in May 2008 over claims of excessive imports of sugar, which were hurting Iranian farmers.

The Majlis approved Mirkazemi as oil minister on 3 September, with 147 votes in favour, 117 against and 19 abstentions.

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