In 1978, Iran became the first country in the Middle East to build a petrochemicals industry, barely one year before Supreme Leader Ayatollah Khomeini was swept to power. But ever since then, the sector has failed to match the ambitions of the Islamic Republic, which is increasingly falling behind its regional neighbours in developing the sector.

Petrochemicals account for almost 40 per cent of Iran's non-oil exports, according to the state-run National Petrochemical Company (NPC). Iran produced 29.7 million tonnes and exported $7.1bn worth of petrochemicals products in the year to March 2009.

Tehran is not short on ambitions for the sector. By March 2010, NPC aims for production to reach 39 million tonnes a year (t/y). By 2015, it hopes to increase total chemicals production to 73 million t/y, taking its share of Middle East capacity from 25 per cent to 29 per cent. If it achieves its goals, Iran will also be the largest methanol exporter in the world by 2013, producing 14.7 million t/y.

Iran is well placed to expand its petro-chemicals sector as it has the world's second-largest gas reserves, at an estimated 28 trillion cubic metres, giving it a secure supply of low-cost feedstock necessary for the development of the sector.

Sanctions impact

However the UN-backed trade sanctions on the Iranian regime are stalling any advances in the sector, leaving it trailing behind the massive capacity upgrades and infrastructure investment in the petrochemicals industry being made by its Gulf neighbours.

For as long as sanctions continue to restrict development, Iran will suffer a severe skills shortage. There was an exodus of professionals from the country when the Islamic Republic was founded in 1979, as well as a further flight around the time of the Iran-Iraq war, from 1980 to 1988. Iran's petrochemicals sector has never recovered from the skills shortage caused by these two events.

According to Iran's Higher Education Ministry, between 1992 and 2005, the number of graduates from Iranian universities grew seven-fold, from 26,000 a year to 180,000 a year.

But even the brightest graduates rarely, if ever, get to travel abroad to study at specialist colleges in the US or Europe, such as the US' Massachusetts Institute of Technology. The result is a shortage of local engineering talent that impairs Tehran's ability to bring its petrochemicals sector up to date.

Ali Meshayeki, head of investment research at Tehran-based asset manager Turquoise Partners, says Iranian engineers have had to develop their owen expertise due to the impact of sanctions, but still lack the specialist skills required to propel Iran's petrochemicals sector into the 21st century.

Other industry observers say even if sanctions were lifted tomorrow, Iran would suffer a time lag in developing its technical capacity.

"The problem is, if you have not done this kind of work before, it takes a long time to learn," says Paul Hodges, chairman of UK-based petrochemicals consultant Inter-national Echem.

Without a domestic skills base to draw on, and with international assistance restricted, Iran's pretrochemicals projects are frequently hit by delays.

"Almost all the start-ups have been delayed by 6-12 months," says Utpal Sheth, Dubai-based director of Middle East polyolefins at chemical industry consultant CMAI. "The reason is technical. Even once they start up, they tend to have teething problems and take a long time getting up to full commercial operating rates."

Pipeline delay

One major project that has been dogged by delays is the west ethylene pipeline scheme, which is designed to transport ethylene 2,163 kilometres from the existing petrochemicals complexes at Assaluyeh and Bandar Imam on the south coast to Mahahad in the northwest of the country. The scheme is aimed at boosting production in the less developed areas of Iran.

Front-end engineering and design (Feed) was carried out by France's Technip and the local Nargan Consulting, while engineering procurement and construction (EPC) work is being carried out by the local OTC and Ger-many's Siemens.

Construction of the 2.8 million-t/y pipeline was scheduled to begin in 2003 with completion timetabled for 2007. But construction did not start until 2005 and the scheme has stalled, with barely 60 per cent of the work completed. The government now says the scheme will be finished by 2010.

Because of the delays, the total price of the project has spiralled from $2bn to $5bn, according to Gulf projects tracker MEED Projects. One source close to the project says the total price is close to $7bn.

Almost $650m has been spent on the project to date and an additional $30m will be allocated by the government to the scheme at the end of June, which may be enough to complete the pipeline's first nine segments, according to MEED Projects. There are 15 segments in total.

The delays could have an impact on Iran's wider development plans. Further delays to the pipeline could undermine the development of the polyethylene processing plants located along its route, as manufacturers find they are unable to produce products for their intended markets.

If these hurdles are removed, Iran's petrochemicals sector might be able to leverage its competitive advantage.

Iran has enormous gas reserves, estimated at 28 trillion cubic metres, second only to those of Russia. These reserves, which are largely at the South Pars field, give it a secure supply of ethane gas feedstock for petrochemicals production and a cost advantage over US and European producers.

In the Middle East, ethane-based ethylene currently costs approximately $100 a tonne to produce, compared with $165 a tonne in the US. European and Asian crackers, largely using naphtha, have a production cost closer to $220 a tonne.

But attempts to boost gas production to meet Iran's export ambitions and domestic consumer and industrial needs has been slow under the burden of international sanctions.Under Iran's economic development plans for 2005-25, gas exports should reach a total of 492 million cubic metres a day, up from 13 million in 2004. But this target is unlikely to be met.

Energy projects require long-term funding, and as international companies have retreated from Iran's energy sector, Tehran has been left with a limited ability to develop the South Pars field.

In the upstream sectors, Western partici-pation has come to a standstill. In 2008, France's Total, Norway's Statoil Hydro, the UK/Dutch Shell Group and Spain's Repsol, which have all been engaged in the development of the South Pars field, said they would no longer invest in the country because of the political risks.

Western co-operation is critical to Iran's gas development plans, as international energy majors bring essential experience and technical know-how. While Iran sits on the world's second-largest gas reserves, its inability to access them is raising questions over Tehran's ability to meet the domestic needs of consumers and industry.

The issue came to a head in the winter of 2008, when temperatures dropped to about -20°C and domestic gas demand increased significantly.

"As domestic gas consumption rose dramatically, the government was forced to reduce supplies to industry," says Meshayeki.

NPC announced plans in July 2008 to invest $30bn by 2015 to realise the country's gas production ambitions. Meshayeki estimates that Iran's plans will require an investment of about $50bn.

Others, including the state-owned Mellat Bank, which specialises in project finance for the energy sector, suggest a figure close to $70bn.

Financing the projects could be covered domestically, says Meshayeki.

New York-based Hassan Ahmed, head of global chemicals research at UK bank HSBC, agrees. "The government views petrochemicals as capital expenditure plus labour," he says. "It helps in job creation and therefore becomes a very high priority."

Some 5 million jobs could be created in the downstream industry, according to the Petrochemical Downstream Industries for Development Office in Tehran.

Asian interest

But this will be a challenge as under new regulations, NPC is restricted to a maximum stake of 20 per cent in any new project, so finance still needs to be found elsewhere.

While US firms are prohibited from doing business in Iran, others are willing to work in the country, and Tehran is increasingly turning to the Asian markets.

The 300,000-t/y high-density polyethylene plant by Mehr Petrochemical, which is due to start this year, for example, is a joint venture of state-owned NPC and a group of foreign companies, including Japan's Itochu and Thailand's PTT Chemicals and Siam Cement Group.

With a stake of 60 per cent held by the foreign companies, the joint venture was the first in Iran's petrochemicals sector in which foreign firms had a larger stake than a local firm.

In April, Turkish/Azeri producer Petkim signed a memorandum of understanding with NPC for a 50:50 joint venture to build a 300,000-t/y polyethylene and 1.65 million-t/y methanol plant in Iran. The financial side of the deal has been agreed, but has yet to be made public.

These deals illustrate the government's drive towards privatisation of the petrochemicals industry. Of the 81 petrochemicals companies in Iran, 51 are in the private sector.

NPC has more than 50 subsidiaries and of these it has so far privatised 28, while 19 others have been earmarked for sale. NPC's stake in these subsidiaries will gradually be reduced to the required 20 per cent. A further three privatisations are planned and "it is not hard to imagine most [petrochemicals companies] will be privatised soon", says Meshayeki.

Foreign ownership

The first deal under which a foreign company took near total control of an Iranian petrochemicals company took place in February 2008. The Turkish consortium led by Gubre Fabrikalari (Gubretas), the second-largest fertiliser distributor in Turkey, bought a 95 per cent stake in the local Razi Petrochemical, previously owned by NPC. It took over management control in July 2008.

This could be the beginning of a trend for foreign ownership, says Meshayeki, but it is hard to say given the currently tough global market conditions.

"There is definitely interest and Asian countries want to participate, even if they do not buy companies outright," he adds.

One example of Chinese interest in winning work developing Iran's petrochemicals sector came in March, when local petrochemicals producer Star Aria Ammonia Chemical Company awarded an engineering, procurement and construction contract to build a 240,000-t/y ammonia plant to the local/Chinese joint venture of China Tianchen Chemical Engineering Corporation and Mehvar Sazan Company.

Iranian projects are certainly commercially attractive, but the political risks, in the short to medium term, make investment difficult.

"In reality, because of the energy discounts, the returns are so high that these petrochemicals projects in Iran make fantastic investments," says Ahmed. "The payback period would only be a few years. The plants have faced multi-year delays, and I have not seen anything in recent months to suggest that new projects will be any different.

"Eventually Iran will be one of the most competitive producers in the world. But it has a long way to go before it gets there."

Despite signs of a thawing in political relations between Tehran and Washington, there is little prospect of a major influx of the much-needed capital into the Iranian gas and petrochemical sectors in the medium term. Without this, Iran will take a back seat as the rest of the Gulf pushes ahead with planned petrochemicals plant capacity increases.