Tehran counts the cost of defiance

29 December 2009

Iran’s hopes of developing a liquefied natural gas industry capable of producing 69.7 million tonnes a year could be derailed by US plans to increase sanctions against the Islamic Republic


The US has begun the process of expanding sanctions against Iran in a move that could affect the Islamic Republic’s gas supplies and hit its ambitions to develop a liquefied natural gas (LNG) industry capable of producing 69.7 million tonnes a year (t/y).

In mid December, the US’ House of Representatives scheduled a discussion to pass amendments to the Iran Petroleum Sanctions Act 1996. US sanctions, imposed in 1996, are intended to deny Iran the resources to further its nuclear programme. They bar US companies and individuals from trading with or investing in Iran, as well as companies from other countries that wish to trade in the US.

Key fact

In 2009, despite its vast reserves, Iran exported just 4 per cent of the 116 billion cubic metres of natural gas it produced

In its next move on sanctions, the US is likely to take a more focused approach, aiming to restrict Iran’s ability to import petroleum and restrict investment in its LNG sector, which is in the early stages of development. “The actual LNG production trains have barely moved forward an inch,” says Samuel Ciszuk, energy analyst at US economic forecasting agency IHS Global Insight. “The sector has been at a standstill for two or three years now. But somebody in Congress has obviously heard that Iran has plans for LNG and has written up a resolution.”

The aim of more targeted sanctions is to increase public pressure on Iran’s government. Iran currently imports 40 per cent of its gas and any shortage of fuel supplies would directly affect its 71 million population.

Production drive

Despite its considerable gas reserves, estimated at 29.6 trillion cubic metres, Iran currently plays only a small role in the global market. In 2008, it produced 116 billion cubic metres of natural gas, 96 per cent of which was consumed domestically. In the four decades since the establishment of National Iranian Gas Company (NIGC) in 1965, its gas exports have amounted to nothing more than occasional deliveries to its neighbours Turkey and Armenia.

According to NIGC, Iran will spend $200bn in an effort to almost double gas production over the next five years to 1 billion cubic metres a day (cm/d) by 2014, from the current 600 million cm/d. But the country has a long way to go to realise its ambitions. Despite its plans to produce about 69.7 million t/y of LNG, Iran has no liquefaction capacity in operation. Progress on construction so far has been restricted to the building of offsite utilities and loading piers by Iranian contractors.

In 2002, Iran began a major project for the development of the giant South Pars field. Estimated to contain 14 trillion cubic metres of gas, about 8 per cent of the world’s reserves, development of the field is divided into 24 phases. To date, more than $20bn has been invested in the project and several phases have been completed. Iran’s target is to increase its annual production capacity to 280 billion cubic metres by the end of 2010, and to complete the project by 2016.

However, European partners such as France’s Total and Statoil Hydro of Norway have abandoned or delayed their contracts because of the sanctions imposed by the US in 1996, and further sanctions brought in by the UN in 2006. In the absence of European and US companies, Iran has been forced to look east for engineers, contractors and technology.

Over the past three years, Chinese, Indian, Malaysian and Russian companies have agreed to invest more than $90bn in purchasing Iranian gas, developing its oil and gas fields, and building pipelines, LNG terminals and other energy infrastructure. But they are not prepared to make the longer-term investments needed to realise Iran’s full gas potential.

“Chinese and Russian companies have shown an appetite for lower-margin projects, but are unlikely to completely break the sanctions,” says Ciszuk.

“Somebody in Congress has obviously heard that Iran has plans for LNG and has written up a resolution”

Samuel Ciszuk, energy analyst, IHS Global Insight

Iran has shown increasing willingness to provide more contractual benefits to China in particular. According to Fereidun Fesharaki, chairman of consultant Facts Global Energy, recent buyback contracts with the state-owned Chinese National Petroleum Company and China Petroleum & Chemical Corporation (Sinopec) provide more flexibility in fiscal terms, shorter payback periods and a 3 per cent higher rate of return for contractors compared with previous contracts.

After nine months of negotiation, National Iranian Oil Company (NIOC) signed a preliminary agreement in June 2009 with China National Petroleum Corporation (CNPC) for the development of Phase 11 of the South Pars gas field, replacing Total on the project. The phase will supply about 70 billion cubic feet a day of gas to the planned liquefaction plant, South Pars LNG, and 70,000 barrels a day of condensate.

NIOC also signed a memorandum of understanding in 2006 with China National Offshore Oil Corporation for the production of 20 million t/y of LNG from the North Pars gas field.

However, according to Fesharaki, it is unlikely that any of these projects will materialise before 2018 or 2019, if ever.

The technology needed to develop an LNG industry is specialised and restricted largely to US and French companies. The involvement of US LNG equipment manufacturers such as San Francisco-based Bechtel is critical to the development of an LNG sector.

“There has never been an LNG plant built without any US-sourced component,” says one Dubai-based engineer. “It can be done, but nobody has done it before.”

Skills vacuum

The new Asian investors are relatively untested in terms of their LNG expertise, and it is far from certain that they have the ability to develop vast, complex oil and gas projects without US technology or contractors. China cannot single-handedly fill the enormous skills and investment vacuum left by the absence of Western companies in Iran.

The availability of US and European technology is not the only problem facing Tehran in its bid to develop a gas export industry. Just as important is the lack of financial resources, especially international financing, for the development of its gas reserves.

US sanctions banning loans to Iran’s banks have been mirrored by European lenders, making it almost impossible for major Western oil companies to do business in the country.

The Iranian government insists that finance can be raised internally. However, this option has been questioned by an unlikely source. Iran’s new oil minister, Masoud Mirkazemi, took office in September 2009, replacing Gholam Hossein Nozari. Speaking to potential investors at the Iran Gas Forum in Tehran at the end of September, the oil minister highlighted the key issue facing the sector. Out of an ongoing project budget of $19bn a year, only $3bn had been transferred from the state budget. “Considering this fact, is it possible to develop the gas industry in the near future?” he asked.

Looking to the future, the potential of the Iranian gas sector is such that companies from both East and West have tried to maintain a presence in the country by carrying out feasibility studies, consultancy work and contracting, in the hope that sanctions will eventually be lifted.

As natural gas becomes more scarce around the world, Iran’s gas resources will become increasingly difficult to ignore. The next few years will be one of the most testing periods for the Islamic Republic’s oil and gas industry as it seeks to overcome technical and financial challenges.

The Iranian government continues to assert that US and UN sanctions are not only ineffective in changing Iranian behaviour, but have only increased its self-reliance in building its economy. 

However, while adding a considerable burden, the effect of the sanctions has been to disguise structural problems within the country that have held back the development of its energy sector. 

“Sanctions are the major problem right now,” says Ciszuk. “But if they were to disappear tomorrow, there would still be major problems for Iran in attracting investment.”

For example, domestic gas consumption is heavily subsidised. Gas subsidies account for 38 per cent of Iran’s state spending.

As the case for further sanctions is stepped up by both the US and the UN, Iran will be closely monitoring which countries it can rely on to help with its energy plans. Karim Sadjadpour, associate at the US’ Carnegie Endowment for International Peace, gives Russia as an example.

“Russia’s modus operandi has been to endorse sanctions against Iran that it itself has watered down,” he says. “This way it can claim to the US and the EU that it is supportive of their position, while privately reassuring the Iranians that it is sympathetic to Tehran’s.”

The contempt of Iran’s Supreme Leader Ayatollah Khamenei for the US has been consistent and enduring for years. He is surrounded, says Sadjadpour, by like-minded ideologues motivated by two predominant instincts: mistrust and defiance.

Until a new regime comes to power in Iran, US and European investment in its gas sector will not progress to a level at which Iran can build a meaningful LNG and gas export industry.

A MEED Subscription...

Subscribe or upgrade your current MEED.com package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications