Tehran struggles to increase oil output

20 March 2009

International sanctions and ageing oil fields have made it hard for Iran to raise production, but the Islamic Republic could do more to make investment in the sector attractive for foreign firms.

Few major oil-producing states will be hit as hard as Iran by the current low prices. Unlike some of its neighbours in the Middle East, the Islamic Republic lacks the protective shield of significant savings, with crude oil receipts largely used to fund current expenditure rather than long-term investment.

Tehran’s political isolation does not help. Despite the tentative approaches made by US President Barack Obama, Iran’s nuclear-enrichment programme means it will remain under a strict regime of international sanctions that strangles foreign investment in its oil and gas sector.

“Low oil prices are bad for everyone, not just Iran,” says Mehdi Varzi, founder of London-based consultant Varzi Energy. “But Iran has separate issues from the others.”

Iran has been struggling to develop its oil and gas sector for the 30 years since the Islamic revolution. In 1977, two years before the overthrow of the Shah, Iran developed a programme to stem the production declines at its large, ageing fields. However, the 1979 revolution and the subsequent Iran-Iraq war prevented the full implementation of the programme.

Annual declines

Punitive measures from Washington have progressively piled on the pain. US sanctions against Iran predate the country’s alleged pursuit of nuclear power status. The Clinton administration first imposed sanctions in the mid-1990s, forcing US energy major Conoco to relinquish its interest in the Sirri fields. Sanctions have been gradually tightened since then, and have affected investment in key oil and gas projects in recent years, eroding any comfort provided by the past decade of high oil prices.

There have been delays in many major investment projects. According to regional energy finance group Arab Petroleum Investments Corporation (Apicorp), based in Dammam, Saudi Arabia, about 29 per cent of the potential energy investment of $96bn has been postponed.

Upstream activity is limited. National Iranian Oil Company (NIOC) launched an oil and gas exploration and development licensing round covering 17 onshore and offshore blocks in January 2007, but only two contracts were signed. Starved of investment and crucial spare parts, Iran is struggling to stem the decline in oil production from its fields, which is thought to be about 8-11 per cent a year. Some commentators say the natural decline rate at Iranian oil fields could be as high as 350,000 barrels a day (b/d).

Despite this, NIOC officials have promised 4.5 million b/d of production by 2010, from a capacity of 4.2 million b/d now. However, such ambitions are unrealistic, according to others.

“If you look at the number of new projects coming on line, such as the Yadavaran, Jofair and Azadegan fields, they will not provide a significant increase in crude oil production because the country is faced with a massive natural decline rate in its oil fields,” says Siamak Adibi, Singapore-based senior consultant at adviser Facts Global Energy. “Our estimates show the best-case scenario is to keep the current capacity of 4.2 million b/d by 2012.”

Adding to the difficulties, NIOC is only able to cover about a quarter of its financing requirements. Abdolmohammad Delparish, director of planning at NIOC, acknowledged in December 2008 that relying on the company’s own resources would result in delays to projects.

This increases the need to attract inter-national oil companies (IOCs) to the country. However, in May 2008, France’s Total announced a freeze on its South Pars phase 11 project, for fear of falling foul of US and UN sanctions. And the UK/Dutch Shell Group announced a month earlier that it would pull out of phase 13 of the South Pars project.

“There is less money to invest, especially where there is a risk involved, such as in Iran,” says Manouchehr Takin, Iran expert at the UK’s Centre for Global Energy Studies. “There simply aren’t thousands of companies queueing outside NIOC’s doors.”

Despite this, NIOC officials insist it can meet its production growth targets, including producing 8.5 million b/d by 2015.

“There is an endemic problem in Iran,” says Varzi. “Iran has to replace its rate of depletion, which is at least 200,000 b/d, before it can even think about raising oil production.”

Of Iran’s current production, 60 per cent comes from fields discovered 50 or more years ago, many of which are fading. The Aghajari field, for example, is currently producing 150,000 b/d, but at its peak it produced 1.2 million b/d. “If your major fields are producing at this level, you have to accelerate your upstream programmes to offset them,” says Varzi. “There is a lot of in-fill drilling taking place [to optimise production], and the number of active rigs has gone up, which is good news. But the problem is that most programmes are being delayed.”

While NIOC can pin much of the blame on sanctions, critics say it has not helped its own cause. “Iran has had more than 10 years of warnings about sanctions, but has proved extra-ordinarily ineffective in overcoming them,” says Varzi. “It could have made upstream activity attractive to foreign companies, giving them a system of contracts granting them an acceptable rate of return, but [it has not] done that.”

The buyback contracts that Tehran favours have consistently failed to whet the appetites of foreign companies, despite a series of tweaks in recent years to offer greater flexibility and a shorter payback period.

Attracting investment

Companies have found that the terms have still deteriorated over time. From the reported internal rate of return of 18.7 per cent that Total secured on its Serri A buyback contract in the late 1990s, the rate of return available to IOCs has fallen to about 11-12 per cent for most projects. Given today’s higher cost of capital, most have chosen to walk away.

That has not stopped the authorities from continuing to develop the contract formula. In August 2008, NIOC managing director Seifollah Jashnaz promised 15 new oil and gas projects involving a “new method” to attract investment.

Since then, it has emerged that Brazil’s Petrobras has agreed a production-sharing contract in the Caspian Sea region, which should provide better returns for the IOC. However, Tehran has made it clear that this will not lead to these contracts being offered elsewhere.

In the absence of interest from most Western oil majors, Iran has chosen to strike deals with major Asian national oil companies (NOCs). China National Petroleum Corporation (CNPC) signed a $2bn, 25-year contract to develop the North Azadegan field in late 2008, which will lead to the production of up to 150,000 b/d in two phases.

The Chinese company is also in talks about taking a stake in phase 11 of South Pars. Another Chinese state-backed group, Sinopec, is partnering with NIOC in phase 1 and 2 of Yadavaran, which will produce 85,000 b/d and 185,000 b/d respectively. Asian firms have negotiated hard on these deals. “CNPC and Sinopec signed buyback contracts in which the rate of return was 3 per cent higher than previous ones, making it more attractive for them,” says Adibi.

But despite the lack of wider interest, the feeling among Iranian analysts is that the Asian presence is less than ideal. “They know the Chinese might be cheaper, but they won’t provide as good a service, and it may even cost them more in the long term due to inefficiencies,” says one observer.

In a sign of domestic dissent at the growing presence of the Asian NOCs, a group of students recently sent a letter of complaint to Iranian President Mahmoud Ahmadinejad asking why upstream deals were being struck with Chinese companies that do not have access to the best technology.

Tehran is still trying to get Western IOCs to commit to the country. NIOC has been putting pressure on Total to make a final investment decision on South Pars phase 2, worth $5bn. Jashnaz has said he hopes a deal will be finalised by the end of the Iranian year on 20 March.

But Yves-Louis Darricarrere, Total’s head of exploration and production, poured cold water on this idea in a statement on 12 February, saying talks were moving slowly and a decision to invest was still far off.

Replacing Total and Shell at South Pars is unlikely to happen in the short term, and the Iranians are likely to hold out for an improvement in the global political environment to get the gas projects moving. “They originally set out a June 2008 deadline for Total to sign, but that was extended,” says Adibi. “NIOC is unlikely to replace them, and even for Total and Shell, Iran remains a strategic country.”

Meanwhile, Asian companies are still pursuing new contracts. A consortium led by India’s state-run Oil & Natural Gas Corporation and Indian Oil Corporation has presented a $3bn plan to develop the Farsi gas block.

Like the oil sector, Iran’s natural gas sector is labouring under a series of unrealistic targets. The official aim is to nearly triple current annual production to 475 billion cubic metres a year (cm/y) by 2020, which would make Iran accountable for 10 per cent of global output. But while it boasts substantial gas reserves, all the major gas developments are well behind schedule.

Much of Iran’s gas will be used for the domestic market, for reinjection into maturing oil fields. Phases 6-8 of South Pars are for gas reinjection, and phases 9-10 and 15-16 are also for the domestic market. The other phases, for which the gas would be converted and sold as liquefied natural gas (LNG) for the export market, are a lower priority.

Iran’s three main LNG projects, Iran LNG, Pars LNG, involving Total, and Persian LNG, which includes Shell and Spain’s Repsol, are all delayed, with the official line being that they are financially unfeasible at the moment. Akbar Torkan, head of planning at the Oil Ministry, has hinted that the preference now is to export gas by pipeline rather than through LNG projects, due to both sanctions and commercial pressures.

The problem for Iran is that its major pipeline export scheme, the Iran-Pakistan-India project, has been hit by pricing disputes, political constraints and continued delays.

In the downstream sector, progress is under way on a series of upgrades to oil refineries, as Iran attempts to redress its status as a net importer of oil products. “Projects are under way and will be on stream,” says Ardibi.

“There are no significant delays on the upgrades and some projects, such as the condensate splitter, are seen as a priority.”

Naphtha derived from condensate splitters is set to rise from 40,000 b/d to 140,000 b/d by 2010, according to Houston-based Asia Pacific Energy Consultants. This comes as Iran’s condensate output is due to rise sharply. The South Pars schemes will bring on stream as much as 400,000 b/d of condensates by 2010.

But the ambitious plans for seven new refining plants outlined in 2007, at a cost of $22bn, which would add 1.5 million b/d to refining capacity by 2012, are unlikely to be realised in the current global financial climate. This will undermine Iran’s target of becoming a net exporter of petroleum by 2013.

Whichever presidential candidate succeeds in this summer’s election in Iran, he will inherit an underperforming, investment-starved hydrocarbons sector that has consistently failed to make the most of its substantial reserves.

This will continue unless policymakers make the right moves to improve the investment climate. But the odds remain stacked against them.

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