Iran Is Entering the Oil and Gas Market; Here’s How It Will Impact Oil Prices
Iran’s grand return to the global oil and gas market could push the Organization of the Petroleum Exporting Countries (OPEC) to change its strategy and slash production in order to prevent oil prices from falling lower. However, a downward oil price forecast resulting from an Iran oil glut or OPEC cuts is unrealistic. The oil market’s reality is more complex.
There is no doubt that Iran wants to increase production and boost oil exports. OPEC does not have any tool to control it, much less Saudi Arabia. The kingdom would bear the burden of having to make the biggest cuts to the relative benefit of its OPEC rivals, which could get away with not having to reduce their current production levels.
Iran is entering the global oil and gas market, but Russia and the United States are not interested in cutting production. Then again, in the United States, production is not controlled by the central government; it is in the hands of private companies. In Russia, the production logic follows the same prescription as in Saudi Arabia: why cut Russia’s production to benefit its competitors?
At the same time, tensions in the Middle East are not easing and Russia’s intervention against the Islamic state in Syria has raised the risk of an international incident involving the United States, Israel, or Turkey.
As for Turkey, the country faces a perfect storm of political and economic uncertainty, as the government faces the prospect of confronting an unprecedented wave of terrorism and Kurdish nationalism.
What Can We Expect from Iran Oil and Gas?
In the short-term, even without additional investments, Iran is already capable of supplying the oil market with an additional million barrels per day. Since the signing of the nuclear agreement last July, Iran has already raised production by about 300,000 barrels per day and could add other 700,000 by January with plenty of room to spare. (Source: “US oil settles down 3.1%, at $51.41 a barrel,” CNBC web site, July 31, 2015.)
New investments could push production to some five million barrels per day (bpd) by 2020, restoring Iran’s oil production potential to about six million bpd; these are levels not seen since the days of the Shah. Compared to the glory days of the monarchy, however, Iran lacks refining capacity and the country has much higher internal energy demand.
After Saudi Arabia, the United States, and the Russian Federation, Iran is the fourth-largest oil producer and holds the world’s second-largest proven reserves. (Saudi Arabia holds the largest) The overwhelming majority of the reserves are located in Iran’s giant oil fields of Khuzestan province, in the southeast of the country near its border with Iraq.
Compared to the 1970s, Iran’s share of oil exports as a percentage of its total production has been gradually thinning due to political turmoil, as well as a doubling of the population and domestic consumption. For political purposes, something that the lifting of sanctions will in no way change is the Iranian government’s subsidizing of fuel, which has pushed domestic demand to about 1.6 million bpd. In 1974, when Iran hit an oil output peak of 6.06 million barrels per day, domestic consumption accounted for only 503,000 bpd, which is less than a third of the current levels. (Source: “Iran needs time and favorable conditions to boost oil output: Kemp,” Reuters, July 15, 2015.)
Iran Entering Global Oil and Gas Market—But Not Overnight
The guarantee of cheap energy, related subsidies, and low income taxes has become even more crucial with the nuclear deal. Indeed, the opening to the West will inevitably see a growing demand for more democratic policies, just as Glasnost did for the Soviet Union under Gorbachev. In that sense, Iran is experiencing an opening that, to use the Persian equivalent of Glasnost, might be called “Goshayesh.” The Iranian political establishment has every incentive to ensure that the population is not pushed overboard by higher prices for basic commodities, which could lead to revolt in a more open political climate.
Then again, inasmuch as Iran will push for higher oil output, its oil fields suffer an annual natural decline of eight percent of productivity on land-based deposits and 10% per year for offshore deposits. The country needs considerable modernization to maintain current production limits; this is why Iran needs foreign investment.
Iran needs western oil companies and oil services specialists like Schlumberger and Halliburton to help prolong well life and improve extraction capacity using such techniques as gas injection.
As for the refining capacity, refined oil generates much higher margins. Many of Iran’s facilities date back to the years of the Shah, explaining why the country has not been able to come close to producing at pre-revolution levels or even those levels hit during Iran’s war with Iraq (1981–1988).
In order to boost production to meet the government’s ambitious target of exceeding five million barrels by 2020, Iran needs to find new deposits. In the next few months, many multinationals and foreign consortiums will sign contracts for the exploration of new areas, but explorers also have to contend with landmines—the legacy of the country’s war with Iraq—slowing down the process.
Additionally, geography brings its own challenges. Iran’s oil fields and installations are located in the south of the country, while most of the cities and the inhabitants live in the north, beyond the great central deserts. Iran needs new internal and external pipelines to facilitate exports. Currently, Japan and China are the biggest Iranian oil importers.
Huge Investments Needed
Iran will have to invest several tens of billions of dollars to achieve the kind of production boost required to have a major impact on oil prices. Surely, demand for oil is increasing in many emerging markets, apart from India and China. However, the amount the government needs to spend to achieve its targeted five million bpd by 2020 suggests Iran will not be selling its resources at bargain-basement prices. In other words, oil prices may go lower or, more likely, higher in the medium- and longer-terms, but not because of a sudden increase in Iranian production.
Certainly, in the wake of the nuclear deal in Iran, there is plenty of enthusiasm and optimism. Iranians are hungry for contact with the West and for the opportunity to be part of the “world” in general, with Iran resuming its role in the community of states. The development of Iran’s economy through the energy sector is just the first step.
Doubtless, the end of the economic and political embargo will help the reformists, which means Iran will be even more open to foreign investment. Those who argue against the nuclear deal ignore history. When a country is isolated, particularly one with a dictatorial government and a state-controlled press, government propaganda is enabled, giving the rulers the ability to dispense whatever “truth” they see fit to retain power. That’s why sanctions worked in South Africa but not in Iran, North Korea, Libya (it had a revolt when Qadhafi’s international relations were at their most open), or Iraq.
Russia, which is eager for higher prices, facilitated the Iran agreement and by taking action against the Islamic state in Syria, it has reiterated its alliance and military and economic cooperation with Iran. In other words, Russia is acting to support a much greater geopolitical and economic role for Iran.
Vladimir Putin, Russia’s president and perhaps the most Machiavellian leader in the world today, is not helping Iran out of some penchant for Persian civilization or because he likes the portrait of Shah Abbas by Mihr Ali in Saint Petersburg’s Hermitage museum. No, Putin understands that oil prices cannot go lower.
After meeting Russia’s energy minister, Aleksandr Novak, OPEC Secretary General Abdalla Salem el-Badri said, “oil prices will get no lower, as demand is surging and production going down,” even if the oil cartel will not be cutting crude output. Novak and el-Badri expect global oil demand to increase by seven percent to 11% a year until 2020, with growth continuing beyond that year, when Iran’s production should reach the five-million-bpd target.
The Russian energy minister said that the situation in the crude market would improve in 2016: “Despite continuing uncertainties, there are possible signs of achieving a more balanced situation in the oil market and to stabilize it by 2016, which is a mandatory requirement for the continuity of timely and sufficient investments,” said Novak. (Source: “Russian, Saudi Oil Ministers Discuss Market Situation,” Financial Tribune, October 7, 2015.) For his part, the OPEC boss noted that the world market would absorb Iran’s oil in the post-sanctions order with ease, stressing that any new fields and projects in Iran would not be developed until five to six years from now.
Finally, foreign companies will not have free rein to exploit Iran’s energy resources. Oil and gas are Iran’s principal economic resources, upon which rests the entire state budget. Under the Constitution of the Islamic Republic, the National Iranian Oil Company (NIOC), state-owned and supervised by the oil minister, is the sole arbiter of the exploitation of energy resources.
The government prohibits private companies from exploring and mining directly, but it does allow buyback contracts, under which foreign companies provide plant and equipment in exchange for rights to extracted oil or gas. The Minister of Industry and Mines, Mohammad Reza Nematzadeh, close to President Rowhani, an engineer and businessman himself, has urged foreign investors to focus less on oil and gas and more on roads, hospitals, automotives, and agriculture. In the oil sector, the minister is less keen on exploration and more on the downstream sectors of refining and petrochemicals.
A law passed in 2002 that grants these 100% property rights, three-year validity visas, and the option to transfer their profits out of the country in foreign currency regulates the activities of foreign companies in Iran. However, in the oil exploration sector, foreign energy companies are reluctant to conclude agreements until the current legislation, a legacy of the Shah’s nationalism and the ostracism of the Islamic Republic, is revised.
Iran Entering Oil and Gas Market Won’t Temper Prices
The full reintegration of Iran into the international oil market will take at least five years. While it needs oil above $100.00 a barrel in order to address its ballooning welfare and infrastructure costs, Iran prefers to focus on the wider benefits of resuming its role in the international market in general. Iran needs foreign investment, advanced technologies, and adequate export infrastructure—all essentially non-existent in Iran today—to achieve its higher production targets. The lifting of sanctions alone does not necessarily ensure this happens.