July 28, 2015

Energy Aspects of the Nuclear Agreement with Iran. Part 1

Oleksiy  Volovych

After the negotiations between Iran and the six major countries of the world (UK, Germany, France, China, Russia and the USA), which lasted all in all for more than 10 years, on 14 July, 2015 in Vienna, a “historic” Agreement was finally signed: in exchange for the termination of the development of a nuclear weapons program, Iran got a chance for suspending and eventually to complete lifting of international sanctions, depending on Iran's fulfillment of certain obligations.

The Agreement is written on 109 pages with 5 appendixes. It provides for lifting of all UN Security Council's sanctions, imposed in 2006, as well as of multilateral and national sanctions against Iran's nuclear program, including with the spheres of trade, technology, weapons, finance and energy. Validity — 10 years. After the signing, the Document was sent to the UN Security Council, which July 20, 2015 unanimously approved the Resolution in support of the Agreement between Iran and the “Six” of international mediators. The adopted Document provides for lifting of all existing sanctions on Iran after the IAEA's confirmation of the fact of Iran's fulfillment of its obligations under the Vienna Agreement. In 90 days after the adoption of this Resolution by the UN Security Council, the Agreement enters into force. During that time, the IAEA inspectors have to make sure that Iran is acting in accordance with the terms and conditions set forth in the Agreement. At the same time in 3 months Iran will receive up to 100 billion US dollars which were frozen under the sanctions.

It is supposed that if the IAEA finds no deviations, the action of seven UN Security Council's Resolutions adopted in recent years on the Iranian nuclear program, will stop. Restrictions in relations between Iran and the international community in various fields will also be gradually removed. The UN Security Council's Resolution also states that sanctions will be resumed in case if Iran does not fulfill its obligations. This mechanism will work for 10 years.

Under the Agreement, Tehran guarantees “under no circumstances Iran will seek to have, develop or have access to any kind of nuclear weapons”. In particular, it pledged not to enrich uranium over 3.67 % for 15 years. Iran and the “Six” international mediators also agreed on the removal of the spent nuclear fuel to Russia for processing, after which it will be returned to Iran in processed form. The arms embargo, cancelling of which is sought by Russia, will act for another 5 years. Twice a year the negotiators will meet and discuss the process of implementation of the Agreements. The European Union is lifting sanctions against Iran on banking operations, insurance, and access to the international payment system SWIFT.

In the political dimension, the most important is the possibility of removing the tension in relations between the USA and Iran. The Agreement signed in Vienna is the first since the Islamic revolution of 1979 and a sign that Tehran is ready for a constructive approach in relations with the United States, whose efforts actually made signing of this Agreement possible. This gives Iran an opportunity to improve relations with the West, as well as to play a more constructive role in the Middle East.

In the USA, the Agreement must be approved by the two Houses of Congress, dominated by Republicans, for the most part opposed to the lifting of sanctions. Congress will have 60 days to review the documents signed. Israeli Prime Minister Benjamin Netanyahu called on American Congressmen to torpedo the Agreement. The USA said that, in particular, it would not lift the sanctions imposed due to Iran's support for terrorist movement “Hezbollah”, “... which is waging war against the friendly Israel”. But B. Obama has warned the Congress of the vote against the Agreement in general, promised to veto the law against the Agreement with Tehran, although if they wished, Congressmen could overcome the President's veto.

The Kremlin's aggressive policy towards Ukraine in 2014-2015 has made the EU accelerate the implementation of a number of measures to reduce its dependence on Russian energy carriers. In this context, Iran is one of the few powerful alternative sources of energy carriers in the world. It is this circumstance that forced the USA and the EU to step up negotiations with Tehran. They were actively looking for a compromise on Iran's nuclear program and lifting of sanctions, which would allow Iran to resume the supply of energy carriers to European countries. It should be borne in mind that the European Union, with all the complexity of its relations with Moscow, will not seek to replace the Russian energy monopoly by the Iranian one. The main objective of the EU energy policy is to diversify sources and routes of transportation of energy resources.

Another factor which contributed to achieving the compromise between Iran and the “Six” leading nations of the world was the fact that the Shiite Iran is virtually the only country in the Middle East, which is really opposed to the promotion of the Sunni terrorist organization “Islamic State” (IS). As you know, Turkey's quite contradictory attitude towards IS, actually blocks the efforts of the countries of the West, trying to provide military assistance to the Kurds in the struggle against the “Islamic State”. Besides Turkey for a long time has been helping the IS in its struggle against Syria.

Immediately after signing the Agreement on the settlement of the problem of Iran's nuclear program, in the global export environment there appeared different estimates and forecasts on how the lifting of sanctions against Iran will influence the further development of the military-political, economic and energy situation, not only in the Middle East, but also in Europe. In our opinion, today most of all are discussed questions around energy issues: How soon will Iran get foreign investments to develop its energy infrastructure? When will the Iranian energy start to arrive in European countries? Will the powerful European and American companies gain access to energy projects in Iran? What will be the relationship between Iran and Russia in the energy sector in the post-sanctions period? Will Moscow and Tehran compete on the European energy market and will they be able to avoid the competition, if they divide the sphere of their energy-related activities? Let us try to answer these questions.

Iran's Energy Potential

In order to understand how exactly Iran's power industry will be transformed in the nearest future, we, obviously, should consider its current energy potential. Revenues from oil and gas sales account for 45 % of Iran's GDP (in 2014 they made 402.7 billion US dollars by the official rate or 1.284 trillion US dollars by the purchasing-power parity). As you know, Iran is the fourth largest in the world (after the KSA, Venezuela and Canada) by the number of proven oil reserves and the second largest (after Russia) in terms of proven natural gas reserves. According to the CIA World Factbook, as of 1 January 2014, the proved oil reserves amounted to 157.3 billion barrels, accounting for about 10 % of world reserves. In 2011, Iran ranked fifth in the world in terms of daily oil production (4.2 million B/D[1]), but in 2013, due to increased international sanctions, crude oil production declined to 3.1 million B/D and the country ranked sixth in the world. In 2013, Iran exported 1.3 million B/D. Iran now consumes about 57 % of the oil produced in the country, while 31 % is exported to Asia and the Pacific Region, and only the remaining 12 %, or 0.4 million barrels a day could be supplied to other countries.

Today, Iran's proven natural gas reserves are 17 % of the world reserves, and more than one third of OPEC countries' reserves. Proven reserves of natural gas in 2014 amounted to 33.8 trillion cubic meters (in Russia — 47.8 trillion cubic meters). In 2010, gas production in Iran amounted to 146 billion cubic meters, and in 2013 it increased to 166.6 billion cubic meters. Practically all the gas produced in Iran is for domestic consumption (144.6 billion cubic meters in 2010 and 162.2 billion cubic meters in 2013). By the volume of exports of natural gas (9.4 billion cubic meters in 2014) Iran is so far inferior to 20 countries around the world. Ranking second in the world in terms of proven gas reserves, Iranian exports of raw materials are rather insignificant, although Iran could be included at least in the top five of the exporting countries. The reason for this unnatural phenomenon is a series of internal and external factors.

More than 90 % of exports of Iranian gas are supplied to Turkey, and the rest — to Azerbaijan and Armenia. It is expected that after completion of the respective pipelines, Iran will supply natural gas to neighboring countries — Iraq, Oman, Pakistan and the UAE.

Iran's oil fields are unevenly distributed across the country. Approximately 70 % of Iran's crude oil reserves are concentrated onshore and the rest are on the shelf of the Persian Gulf and the Caspian Sea. Most oil fields are located in the province of Khuzestan, in the South-West of Iran, near the Iraqi border. Over 50 % of Iran's oil exports go to the Far East (to Japan, China and South Korea), and the rest — to Europe and Africa. According to the US Energy Information Administration (EIA), Iran's exports of crude oil and condensate began to increase in late 2013, and averaged 1.4 million B/D in 2014, almost 150,000 B/D above the level of 2013.

The “South Pars” gas field situated on the shelf of the Gulf is the largest in Iran. Its area is about 3700 square kilometers, and its proven gas reserves — up to 14 trillion cubic meters, accounting for 8 % of the world's and half of Iranian gas reserves. Approximately 80 % of the Iranian hydrocarbon reserves had been explored before 1965, so it is possible that new large deposits will be discovered. According to the FGE, Iran has the highest rate of natural gas production, estimated at 79 % compared with the world average ratio — 30 % to 35 %.

According to Iran, in 2011, in its territorial waters of the Caspian Sea at a depth of 700 m a huge oil and gas field “Sardar Jangal” was discovered. According to preliminary estimates, the oil reserves there amount to approximately 8 billion barrels and reserves of natural gas — to 50 trillion cubic meters, which significantly increases Iran's gas reserves, bringing it to the top in the world, well ahead of Russia and Qatar. Azerbaijan also claims to be a part of this field, which is another factor of tension in the already difficult relations between Baku and Tehran. The unsettled distribution of the Caspian Sea also slows down the production of Iranian hydrocarbons.

Since the sanctions imposed by the West complicated Iran's access to advanced Western technologies, Iranian specialists had to learn new efficient technologies. In particular, they debugged the construction of offshore platforms for oil and gas production. Now they are completing the construction of three plants for liquefied natural gas. One of them, with the capacity of 100 million cubic meters a day, is being built in cooperation with Chinese companies in the area near the “North Pars” field. The other two plants are being built in the same place together with European companies. Their daily capacity is 50 and 75 million cubic meters of gas. These plants were planned to be constructed in 2013-2014, but due to international economic sanctions, the timing of their commissioning was postponed to 2016.

Iran's Loss of Profit due to International Sanctions

Virtually the Islamic Republic of Iran came under the impact of international sanctions since its founding in 1979. The large country (the area is 1,648 thousand sq. km, population — about 80 million people) with the ancient culture, counting for several thousand years, with huge reserves of oil and gas, for a long time was on the periphery of international politics and economy, from which, in fact, not it alone suffered losses of profit, but a lot of other countries did, in particular European ones, Ukraine included.

Because of the oil embargo, imposed by the USA and the EU in 2002, due to the suspicion that Iranians were developing nuclear weapons, Iran lost each month 4 to 8 billion US dollars. The most severe sanctions, tough financial restrictions and the oil embargo were introduced in 2011-2012. In particular, the USA and EU's sanctions prohibited large-scale investments into Iran's oil and gas sector and limited its access to European and American financial sources. Since the beginning of 2012, Iran had been disconnected from the SWIFT banking system and was in financial isolation. Any investment into its oil and gas sector and into the high-tech industry were prohibited.

Under the threat of punitive measures, the French Total, the Italian Eni, Norway's Statoil and the British-Dutch Royal Dutch Shell gave up investing into Iran. However, many Asian partners of Iran, such as China, Taiwan, Japan, South Korea, India, Pakistan, Turkmenistan, Turkey, ignored those sanctions. And so did Afghanistan, Singapore, Indonesia, Malaysia, the Philippines, Sri Lanka and so on.

Iran had permission to export no more than 1.1 million barrels per day (on the verge of survival), although before the sanctions the exports had been 2.5 million barrels per day. However, Iran did not reduce production and pumped oil into storage facilities, in hope for the rapid resumption of exports. Revenues from exports fell from 100 billion US dollars to 35 billion US dollars. Iran's GDP fell by 20%. GDP per capita in the years of sanctions fell from 12 thousand US dollars per capita to 6 thousand US dollars. The EU imposed an embargo on Iranian oil and forbade insurance of Iranian oil tankers. As a result, Iran's oil exports to Europe in 2012, compared with the previous year, fell by 78 %.

International sanctions and oil embargo negatively affected the economic situation of the country. Thus, according to the International Development Research Centre (London), Iran was annually losing about 40 billion US dollars. The inflation in the country amounted to 25 %, the unemployment rate — to 20 %. At the end of 2011 and during 2012, the United States and the European Union imposed sanctions against Iran, which had a particularly bad impact on the energy sector, in comparison with the previously introduced sanctions. The total oil production in Iran in 2014 was nearly 200,000 B/D more than in 2013, but by 800,000 B/D less than in 2011 before strengthening of the sanctions — 4.2 million B/D. Due to international sanctions crude oil production in Iran fell sharply from nearly 3.7 million B/D in 2011 to 2.7 million B/D in 2013. In 2014, Iran was producing 2.8 million B/D of crude oil and 6 million B/D of oil and gas condensate.

If in the 2011/2012 fiscal year, Iran's revenues from exports of oil and natural gas made 118 billion US dollars, in the 2012/2013 fiscal year, revenues fell by 47 % — to 63 billion US dollars. According to the IMF estimates, the income from oil exports and Iran's natural gas fell again in the 2013/2014 fiscal year by 10 % — to 56 billion US dollars.

Over the past few years, Iran was exploring and developing new oil fields, but sanctions did not allow to realize these projects. Projects were slowed down, and in some cases — canceled due to the sanctions and the lack of modern technologies and investments in Iran. However, development of some projects continued, although more slowly than originally planned.

Apart from crude oil and condensate, Iran also exports oil products. According to the FGE, in 2014 Iran exported nearly 300,000 B/D of petroleum products, about 50,000 B/D more than in 2013, but about 100,000 B/D less than in 2011, as the US and EU sanctions also had a negative impact on Iran's ability to sell petroleum products. However, Iran aims to ramp up production and sale of petroleum products.

Lifting of international sanctions against Iran, no doubt, will seriously affect the national, regional and international economies. Among the main beneficiaries, apart from Iran, there will the EU and South-East Asia countries, which will receive additional sources of energy carriers. It would be great if Ukraine were among these countries.

Prospects for the Development of Iran's Energy Sector after the Lifting of Sanctions

Iran is opening itself to the world, its demographic, resource and economic potential have attracted the attention of large multinational investors. Even before the sanctions were lifted global energy companies had been consulting with the Iranian leadership on the topic of the resumption of their activities in Iran. Thus, the management of the Anglo-Dutch Shell and Italy's Eni since May 2015 has been negotiating with Oil Minister Bijan Zanganeh on investments into the Iranian energy sector after the lifting of sanctions. Immediately after signing of the Agreement in Vienna, the Iranian Oil Minister B. Zanganeh met with the management of Shell, Eni, Total, BP and “LUKOIL”. According to the Iranian government, Iran's energy sector requires investments of 300 billion US dollars for 8 years.

According to some experts, with the help of foreign investments, the current level of oil production in Iran (2.7 million B/D) can rapidly rise to 3.3 million B/D.

With the volume of foreign investments into Iran's oil industry equal at least 50 billion US dollars, by 2020 the oil production will amount to 4,4-5 million B/D, which can significantly influence the world oil market, and the price for it. In April last year the country's Oil Minister B. Zanganeh defined a new goal — production of 5.7 million B/D of crude oil already in 2018. If Iran succeeds, it will be the third largest exporter of oil in the world after Saudi Arabia and Russia. According to the IEA, if a large amount of Iranian oil has arrived in the world market by the end of the year, a barrel of oil in 2016 may go down in value by 5-15 US dollars.

As it has become known, with the help of international oil companies, Baghdad is planning by 2020 to triple oil production, to 9 million B/D. Thus, Iran along with Iraq before the end of the decade may seize world leadership in oil production from Saudi Arabia and Russia, each of which produces about 10 million B/D of oil. At this, it should be noted that the KSA is the second in the world after Venezuela (298 billion barrels) by oil reserves (268 billion barrels), while Russia is the eighth (80 billion barrels). Thus, Iranian oil reserves (157.3 billion barrels) are twice as large as Russian ones.

At the moment, Iran keeps more than 20 million barrels of crude oil in supertankers anchored in Iranian ports ready to send the oil to consumers as soon as there is the UN Security Council's appropriate solution in accordance with the Agreement signed in Vienna. According to the Thomson Reuters Institute, back in March 2015, on the raid of Iranian ports there were 14 supertankers, nine of which were completely filled with crude oil, and the rest — by about 60 %. Iran also rents storage facilities in China, where it also keeps Iranian oil.

In preparation for the lifting of sanctions, Iran was also considering options to export its natural gas. Thus, speaking at the end of January 2014 at the World Economic Forum in Davos to representatives of international energy companies (BP PLC, Eni SpA, Royal Dutch Shell PLC, Aramco, Total S.A.) Iranian President H. Rouhani said that Iran was ready to resume constructive cooperation with European countries to ensure global energy security. In autumn of 2014 on the sidelines of the UN General Assembly in New York, Iranian President Hassan Rouhani in a conversation with President of Austria Heinz Fischer said that, taking into account the Russian-Ukrainian conflict, which may cause delays in the supply of Russian gas to the EU, Iran offers its gas to Europe. Although Iran was not actively developing gas export capacity, according to experts, the potential for gas production in the country is still quite impressive: it is assumed that by 2020 Iran could produce approximately 215 billion cubic meters of gas, and it will provide an opportunity to export up to 35 billion cubic meters of gas per year. In October 2014, Iran also prepared a plan for exploration and production of significant reserves of gas hydrates on the shelf of the Oman Sea.

In our opinion, to have reserves of gas, by volume ranked second in the world and to export a very small part of them is irrationally. Therefore, if after the settlement of the problems surrounding Iran's nuclear program, Iran does not significantly increase oil and gas supplies to Europe, it will soon significantly affect its national security. Apparently, simultaneously with building-up of gas production, Iran will start the construction of main international gas pipelines.

The existing Tabriz-Ankara pipeline with the capacity of 14 billion cubic meters of gas within a year could potentially connect Iran to the European market. At this, the Iranians would need to build another gas pipeline to increase the supply. It is possible that they will resume the construction of the “Pipeline of Friendship” (Iran-Iraq-Syria) 5,000 kilometers long, which will connect the gas field “South Pars” to the Mediterranean coast.

Since 2009, the Iran-Armenia gas pipeline “Tabriz-Meghri” (length of 140 km and a capacity of 1.1 billion cubic meters per year) has been functioning. By 2019 it is planned to have increased the capacity of the gas pipeline to 2.3 billion cubic meters of gas. Russian “Gazprom” participated in the construction of this pipeline, and it also owns 45 % of its shares. Ukraine has also expressed its readiness to participate in the construction of the pipeline and its construction through Ukraine's territory to Europe. But Russian “Gazprom” has blocked these plans.

In November 2012, in accordance with the Agreement signed by Oil Ministers of Iran, Iraq and Syria, in July 2011 Iran started construction of its part of Iran-Iraq-Syria-Europe gas pipeline. But it stopped because of both, the unstable situation and unrest in Syria and Iraq, and because of the lack of financial resources in Iran due to the sanctions.

In 2013 it was planned to start construction of the pipeline IGAT-9 (costing 7 billion US dollars with a maximum capacity of 37-40 billion cubic meters a year) from the field “South Pars” to the city of Bazargan on the Iranian-Turkish border. It was planned that the Turkish pipeline would be laid into Greece, Italy, Switzerland, Germany, France and Spain. The total length of the pipeline — 3300 km (the Iranian sector — 1800 km, the Turkish one — 660 km, the rest — on the territory of the above-mentioned European countries). However, due to the boycott by Western oil companies, Iran was forced to suspend this project.

Exacerbation of relations between Iran and Turkey in connection with the civil war in Syria, in which Ankara supports the Syrian opposition, and Tehran — B. Assad's regime, did not add to implementation of this project either. Tehran condemned the dislocation of American Patriot SAM batteries on the Turkey-Syria border. In its turn, Ankara accuses Tehran of supporting militants of the separatist Kurdistan Workers' Party (PKK), which are based in the territory of Iranian Kurdistan. However, despite the deterioration in Turkish-Iranian bilateral relations, Turkey continues to buy Iranian gas. Apart from gas, Turkey imports from Iran almost half of the oil it consumes. Such interdependence of the two countries to a certain extent guarantees that Ankara and Tehran will not cross the “red line” in their relations. Turkey is ready to increase import of Iranian gas under the condition of price reduction, which is 490 US dollars per 1 thousand cubic meters, which is much higher than the price for delivered to Turkey Russian and Azerbaijani gas. In February 2015, the International Arbitration Court began sittings under the claim to Iran from Turkey, requiring to reduce the price by 25 %.

Features of Iran's Law in the Energy Sector

In 2002, Iran adopted a new law on attracting foreign investments. However, this law, like the previous one of 1975, determines a rather complicated procedure for foreign investments into the oil and gas sector of the Iranian economy. In fact, a lot of restrictions remained for getting permits to conduct such activities. In particular, it prohibits the use of foreign investments if they can lead to special rights and privileges of foreign companies. Concession agreements are not allowed, nor are foreign direct investments into the economy of Iran. It is not allowed to establish enterprises with 100 % of foreign capital. Foreign companies may be engage in activities in Iran only in cooperation with Iranian partners. After completing the registration procedure established by law, the formed company receives in the appropriate Iranian Ministry a founding license and enters a framework agreement.

The law gives foreign investors the right to return the initial investments, according to the previously agreed fixed rate, due to the goods and services sold within the framework of the project. Terms of BOT (build — operate — transfer) allow for the gradual transfer of the object into the ownership of the Iranian customer in the course of reimbursement of the investor's spendings. However, investors are reluctant to sign this type of contract because after the return of funds spent and receiving fixed interests, they completely leave the object, which then begins to work exclusively for Iran. Due to this, foreign investors are trying to persuade the Iranian leadership to accept more profitable for them agreements on the terms of the Distribution Agreement (PSA), but the PSA has not been confirmed in the local legislation yet. In recent years, foreign capital has been involved in Iran's economy up to the conditions of finance, where the investor after the introduction of the facility into service receives payments in foreign currency. The investment legislation offers foreign capital the national treatment and most favored one, and also removes restrictions on foreign investors' participation in the state sectors of the Iranian economy. However, despite the guarantees provided to the investor by the Iranian government, there is uncertainty regarding the legal protection of foreign investments, which results in an extremely low level of net foreign direct investments into the Iranian energy sector.

According to the consulting firm Energy Pioneers, right now Iran is developing draft contracts. They will offer foreign companies more attractive terms, which will provide for partnership within the framework of joint ventures. In particular, foreign investors will be offered interest rates, taking into account the level of risk and the price of oil, rather than fixed interests, as it was before. Besides, the duration of the contracts will be increased to 30 years.

To be continued...

Oleksiy Volovych, Odesa

[1] Abbreviation "B/D” means — Barrels per Day. Generally accepted in the world one barrel of crude oil contains 42 US gallons — 158,988 liters. A barrel is used as the main unit of measurement in the world oil market, and the price of the world's major brands of oil is set in US dollars per barrel.