The US House of Representatives voted in favour of the Iran Refined Petroleum Sanctions Act in December last year. If passed by the US Senate in the coming months, this will give President Barack Obama the power to impose sanctions against companies that provide Iran with, or support Iranian production of, petrol and other refined products.

The proposed sanctions present a direct threat to Iran’s ambitions to expand its petrol production. Tehran has, however, dismissed the threat. On 15 September, inaugurating Masoud Mir-Kazemi as his new oil minister, Iran’s President Mahmoud Ahmedinejad shrugged off the US plans, describing them as “impossible” to enforce.

Inefficient refineries

Tehran has long been aware of its vulnerability to a petrol embargo. Despite being home to the world’s second largest proven oil reserves, estimated at 138 billion barrels, the Islamic republic has to import fuel, due to its ageing and inefficient refinery infrastructure. But it has been taking steps to counter the threat by seeking to increase its domestic refining capacity, secure alternative energy supplies from friendly nations and reduce consumption.

Iran’s current crude oil refining capacity stands at about 1.5 million barrels a day (b/d), compared with Saudi Arabia’s 2.1 million b/d.

In October last year, Tehran stated that it was seeking to raise production to 3 million b/d by 2012, but progress in modernising its refineries has been slow and reliance on petrol imports is still heavy.

The Oil Ministry plans to increase imports of petrol by 5 per cent to about 22 million litres a day by the end of March 2010. Iran has on average imported 21 million litres a day since March 2009, with consumption averaging about 66 million litres a day.

Some of Iran’s traditional suppliers have already pulled out of the market, possibly in anticipation of tighter sanctions. India’s Reliance Industries began production at its 580,000 b/d refinery at Jamnagar in the Indian state of Gujarat in December 2008, with supplies earmarked for Iran. But the company is reported to have cut off petrol supplies to Iran in June 2009, despite continuing to import crude oil from the Islamic republic.

Other suppliers, such as France’s Total, which currently still sell petrol to Iran, have indicated that if sanctions are imposed energy supplies will stop.  In November last year, Christophe de Margerie, chief executive officer at Total, stated in a speech at Columbia University in New York that “if there is a law that tells us to stop, then we will”.

But Iran still has a few allies remaining and has been seeking to increase petroleum supplies through these international alliances.

Since August 2009, Malaysia’s Petronas has been supplying Iran with petrol. Analysts report that Chinese companies are also currently supplying between 30,000-40,000 b/d of petrol to Iran, about a third of the country’s total requirement.

Following a two-day visit by Venezuelan President Hugo Chavez to Iran in September last year, the state-run energy firm Petroleos de Venezuela signed an $800m deal to supply Iran with 20,000 b/d from October 2009 to help plug any shortfall in imports.

Russia is another potential source of imports, given its huge refining capacity.

“Refinery utilisation north of the Caspian is running at 70 per cent, so this is a possible source,” says Fariborz Ghadar, a senior trade adviser at the US’ Centre for Strategic and International Studies. “But this would be expensive, as it would need to be trucked in. It is a question of price versus availability.”

Given Iran’s gas potential, major energy companies will be reluctant to sever their ties with Tehran completely, sacrificing lucrative future contracts. Total, for example, made a decision at the end of 2008 to halt its investments in Iran, but its interest in the country remains.

At the end of December 2009, Total said it was reviewing its co-operation with China National Petroleum Company (CNPC) on Iran’s South Pars gas field, with a view to returning to the project. In June 2009, CNPC and Iran’s National Iranian Oil Company signed a contract for the upstream development of phase II of the South Pars field, replacing Total.

Until Iran’s refining capacity is increased, the country will have to innovate to keep up with demand. In November, Iran began experimenting with a novel approach, producing petrol from its petrochemicals plants. Mir-Kazemi described the unconventional move to the local press as one which showed “the West cannot use limitations on selling petrol to Iran as a tool against the Islamic republic”.

Mir-Kazemi says the method could produce as much as 14 million litres of petrol a day, a significant addition to the 58.5 million litres a day that is already produced in the country. The plan comes at a significant cost, however. According to Darren Smith, Middle East analyst at petrochemicals consultant Chemical Market Associates, Iran would have to cease making paraxylene in order to use its aromatics units to produce a high-octane mixed aromatics stream that can be blended into the petrol pool.

Increased storage

At the same time, Iran has been seeking to increase its strategic reserve in advance of any sanctions. In August last year, Farid Ameri, managing director of National Iranian Oil Products Distribution Company said Iran planned to increase its fuel storage capacity to almost 11 billion litres, up nearly 15 per cent from 9.4 billion litres.

About 1.45 million barrels of oil are stored on tankers anchored off the coast of Kharg Island in the Persian Gulf. Iran has the largest oil tanker fleet in the Middle East. The National Iranian Tanker Company holds 29 ships, including very large crude carriers.

The need to have a larger strategic reserve is in part driven by the republic’s heavy demand for fuel. Tehran’s policy of subsidising energy costs to domestic customers has resulted in high and rising consumption.

In December last year, a bill designed to gradually remove energy subsidies and reduce consumption over the next five years was approved by the Iranian parliament and is currently with Iran’s Guardian Council, which approves all new laws. But an ongoing dispute between the president and parliament over who should control the revenues saved from cutting subsidies is expected to sink the proposal.

In 2007, the cost to the government of subsidising energy costs exceeded $50bn, about 40 per cent of the republic’s gross domestic product. Iran’s 2.4 million car drivers were the biggest beneficiaries, receiving $21.3bn, or 42 per cent of the total subsidies package.

Some steps have already been made to rein in consumption. In June 2007, a rationing scheme was implemented after more than a year of waiting for government approval. Car owners were provided with a smart card, giving them access to a quota of subsidised petrol at $0.10 a litre, compared with open market prices of about $0.70 a litre. Additional petrol can be bought at market prices.

Not surprisingly, in a country which has for so long been identified with vast hydrocarbons riches, energy price increases have proved hugely unpopular.

The decision to ration petrol was not without incident. Five filling stations in the capital were set alight by angry motorists. But the rationing system remains.

In the month following the implementation of rationing, average consumption fell by a quarter to 359,000 b/d from 491,000 b/d. But, over time, the rationing has only slowed the growth of fuel consumption rather than halt it. With the country’s car manufacturing industry growing fast, and cars becoming affordable to more and more consumers, the likelihood of fuel consumption levels falling is low.

The removal of fuel subsidies could result in higher inflation. In September last year, Fereidun Fesharaki, chairman of US’ Facts Global Energy, told the Centre for Strategic and International Studies in Washington that a move to market prices would result in an increase to inflation of 15-20 per cent.

Tehran concedes that it will not be able to support the heavy subsidy burden in the long term. Boosting Iran’s domestic refining capacity will help reduce the cost of petrol, which in turn will ease the pain of removing fuel subsidies. But Tehran will, if the US sanctions are approved, find it tough to secure the right partners to help it refine its oil riches.