Tehran’s grand gas ambitions

03 November 2009

Iran aims to almost double gas production and become a major supplier to Europe within the next five years, but its plans are unlikely to be achieved

The gap between rhetoric and reality in Iran is, it seems, as wide as ever. According to the head of the country’s gas industry, the Islamic Republic will spend $200bn in an effort to almost double gas production in the next five years, and is petitioning to become the main supplier to a major planned pipeline project to take gas to Europe. But there is little hope of these targets being reached within such a short timeframe.

“We are going to extend production from 600 million cubic metres a day [cm/d] to 1 billion cm/d by 2014,” Azizollah Ramezani, deputy energy minister and managing director of National Iranian Gas Company (NIGC), said on the margins of the triennial World Gas Conference in Buenos Aires on 9 October. “For this expansion, we need new gas refineries, new gas field developments and new pipelines, mainly for export and partly for domestic use. We plan to spend $200bn.”

According to Ramezani, Iran aims to supply more than half of the gas to the proposed Nabucco project, which is designed to transport 30 billion cubic metres a year (cm/y) of natural gas to Europe from Central Asia and the Middle East. “In our opinion, countries such as Azerbaijan, Turkmenistan and the other countries in the Caspian region are not able to supply this amount of gas,” he said. “We are ready to discuss supplying most of the natural gas for this pipeline and we hope we can get more than a 50 per cent share in the supply.”

Questionable assessment

But analysts doubt that Iran can get anywhere near these targets. Even the country’s assessment of its current production levels is questionable, according to Faezeh Foroutan, senior consultant at Tehran-based business strategy consultant Atieh Bahar. “Actual production capacity in August stood at 497.5 million cm/d,” says Foroutan. “The desired production capacity may be 600 million cm/d, but it has not been realised yet.”

The prospects for practically doubling this capacity and freeing up substantial gas for the export market are marginal at best. “The whole export aspect of Iranian gas has been so deeply disappointing that it is very, very difficult to imagine things will change radically in the future,” says Jonathan Stern, director of gas research at the Oxford Institute of Energy Studies in the UK.

If the targets are to be met, Iran will need to overcome four major barriers: domestic gas subsidies; gas reinjection demand; political obstacles to foreign financing; and an unappealing contract model for international companies.

Key facts

  • $200bn - Value of Tehran’s spending plans for its gas sector
  • 27 per cent - Rise in domestic and industrial gas consumption in Iran in year to September

Source: MEED

Iranshould have more than enough gas to be one of the world’s major exporters. Its reserves are second only to Russia’s and account for 16 per cent of the global total, while its production is the highest in the Middle East.

But huge domestic demand means that Iran is a net importer of gas. In 2008, it exported 5.8 billion cubic metres of gas but imported 6.9 billion cubic metres, according to the 2009 Statistical Review of World Energy by UK energy major BP.

Rapid growth in electricity demand is also putting an increasing strain on the avail-ability of gas in the country. Since 2000, electricity demand has risen by an average 7.8 per cent a year, and Tehran estimates it will need to increase its electricity generating capacity by about a third by 2015. According to reports in the local media in early October, domestic and industrial gas consumption between March and September this year was 25.1 billion cubic metres, up 27 per cent on the same period in 2008.

Subsidised prices

According to analysts, the reason for such high local demand is the country’s policy of subsidising domestic gas and electricity prices, which are the lowest in the Middle East. “Just to cover the cost and delivery of domestic gas they would need to multiply the price by five or more,” says Stern. “It is not remotely certain that this is realistic.”

According to Ramezani, Iran plans to eradicate subsidies “during the next five years”, but this will be more easily said than done. In mid October, the Iranian parliament ratified a bill calling for a gradual increase in domestic gas prices to 75 per cent of export gas prices by 2015. Export prices were not defined, but are thought to be based on the current export rate to Turkey, which in 2008 was $0.32 a cubic metre.

While the bill’s timeframe is not quite as ambitious as that suggested by Ramezani, parliament’s approval for the policy is a significant step forward. But implementation will be an altogether different challenge. The Iranian people see cheap energy as their right – when petrol rationing was introduced in 2007, the result was rioting in the streets and the torching of petrol stations.

“It is anticipated that the plan will face serious challenges and [that] will force the officials to revise it during the initial stages of implementation,” says Foroutan.

The delicate political situation following disputed presidential elections in the summer may also hinder the plan’s implementation.

“Subsidies are a hugely political issue and need to be dealt with by a government that is confident about its legitimacy,” says Stern. “Given the events of the past few months, it is not at all certain they have any reason to be confident. At minimum, it is a really big ask.”

The second limiting factor in Iran’s ability to increase the proportion of gas it exports is the country’s massive demand for gas reinjection to support production from ageing oil fields. BP’s 2009 review estimates Iran’s net production of natural gas in 2008, after flaring and recycling, stood at 116.3 billion cubic metres, less than two thirds of total production, given a daily rate of 500 million cm/d.

“It is anticipated that the plan will face serious challenges and [that] will force the officials to revise it”

Faezeh Foroutan, senior consultant, Atieh Bahar

A significant share of incremental gas production is also going into reinjection. Most of the gas from phases 6, 7 and 8 of the massive South Pars gas field development, which are expected to reach full production of 104 million cm/d this year, will be injected into the Ashajari oil field. “The massive scale of their reinjection requirements seems to overwhelm any production increases,” says Stern.

In addition to addressing the issue of domestic consumption, Iran must also continue to increase supply if it has any chance of realising its ambitious targets. The combination of international barriers to investment and the unattractive contract terms on offer for foreign firms makes this equally problematic.

Most of the gas projects now on stream were embarked upon during the presidency of Mohammad Khatami between 1997 and 2005, when the country had greater access to overseas financial markets. Now, not only is the market for international finance tighter than ever, but Iran faces the additional problem of international sanctions, resulting from its nuclear energy policy.

Although US sanctions against companies investing more than $20m a year in Iran’s hydrocarbons sector have not been applied, sanctions barring lending to the country’s main banks are in force, and have largely been mirrored by European lenders.

The difficulties of raising finance, coupled with informal diplomatic pressure on Iran from Europe and the US, has made it almost impossible for major Western oil companies to do business in the country. BP and France’s Total have both halted major investment plans, pending resolution of the international stand-off. EU officials have meanwhile stated that Iranian gas supply to the Nabucco pipeline would not be possible in the current political climate.

Internal money

Ramezani insisted that the country can continue to develop its gas industry in the absence of international finance. “If the foreign financial market is not sufficient, we will use internal money,” he said. “We have big savings and can finance internally the main part of our projects.”

Iran’s fiscal position has improved significantly in recent years. The economy grew by an average 5.9 per cent a year between 2000 and 2007, and bumper hydrocarbons revenues in recent years have enabled a reduction of external debt.

But the country still faces severe financial constraints. The treasury has been hampered by unwieldy energy subsidies, costly gasoline imports to compensate for inadequate refining capacity, and endemic inefficiencies in government spending.

The falling oil price since the summer of 2008 has meanwhile eroded the benefits of the administration’s efforts to build up funds for infrastructure development.

“The idea that Iran could raise tens of billions of dollars is unrealistic,” says Stern. “Even with the oil price where it is now, it is very unlikely.”

And Iran shows no sign of backing down from its nuclear development policy. “Every country should diversify its sources of energy and Iran is not an exception,” said Ramezani.

“The idea that Iran could raise tens of billions of dollars is unrealistic…even with the oil price where it is now”

Jonathan Stern, Oxford Institute of Energy Studies

Ongoing negotiations with the international community mean that the possibility that sanctions might be lifted cannot be ruled out. If this were to happen, the country’s ability to accelerate its hydrocarbons development programme would increase dramatically.

But even if this were to happen, international oil companies (IOCs) have reservations about the terms on offer for the development of Iran’s hydrocarbons. Constrained by constitutional restrictions on foreign ownership of the country’s resources, most deals have been done on a ‘buy-back’ basis. Under such contracts, IOCs work on the development of a field before transferring ownership to Iranian authorities.

The format has proved unpopular with foreign firms, who cannot add the reserves to their international portfolio and have little say in how the fields are run once ownership is returned to Tehran. “Buy-back contracts don’t excite many people,” says Stern. “IOCs are all about bookable reserves – anything else is not so valuable to them.”

Although NIGC revised its buy-back contracts in February 2007 and improved the terms on offer, there is no prospect of a wholesale shake-up of the contract model. “We prefer to have buy-back contracts for field development,” said Ramezani.

In recent years, talking up the prospects for Iran’s hydrocarbons development has become habitual among the country’s energy industry officials. With rumours of an imminent reshuffle at the Petroleum Ministry, putting additional pressure on Ramezani to show how well things are going, it seems that the latest grand designs are no exception.

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