Analysis: Iran’s oil shortfall

IHS Global Insight Middle East energy analyst Samuel Ciszuk gives his expert opinion on what this means for Iran’s energy sector.

Outlining the problems facing his ministry on the outset of his tenure, new Oil Minister Masoud Mir-Kazemi was quoted as saying that he foresaw a gas shortage during the winter peak demand season of about 200 mmcm/d, which likely would translate to heating and electricity shortages in some of its most populated areas, according to Iranian daily Abrar. Appearing to want to reset expectations, Mir-Kazemi countered previous optimistic official Oil Ministry estimates, which maintained that Iran would not need any additional gas imports to meet its spiralling domestic demand thanks to rapid upstream development at its vast South Pars offshore gas field in the Gulf.

The previous optimistic estimates—likely a product of the government’s re-election campaign—resulted in no allocations for diesel imports in this year’s budget, meaning that the already strained Iranian state finances will suffer, with much of the burden likely being carried by the Oil Ministry’s own capital expenditure budget. According to Reuters, Iran has bought its first diesel cargo for about six months, for a likely September/October delivery, as it commences on an inventory build-up operation. The news come just a month after Iran halted all its exports of diesel and indicates that the Oil Ministry is preparing for the use of diesel as feedstock in some of its gas-fired power plants—an expensive measure suitable only to stave off emergencies.

Iran has suffered severe gas shortages in previous years, as it has been unable to match its spiralling domestic gas and electricity demand growth by similarly speedy upstream and downstream developments of its vast reserve base. Iran does not need only to develop the upstream production and the treatment facilities for its gas. Its geography also places on it the need to invest in long and relatively expensive pipelines, carrying the gas from its lowly populated southern and south-western Gulf shore over the central mountains to its densely populated mountainous north. Because of a lack of sufficient funding—aggravated in the past years also by a spike in steel prices—Iran has not been able to install sufficient gas transport capacity to its main population areas, leaving large parts vulnerable to the previous year’s gas-price dispute with Turkmenistan.

Funding Pressure

Iran remains one of the OPEC member countries most vulnerable to oil-price fluctuations, with the virtual doubling of the oil price since last year’s low only having rescued it from vast deficit, without placing it on a sure financial footing. The extent of Iran’s financial woes was further underlined by Mir-Kazemi saying that “there are around $19 billion worth of incomplete projects in the gas industry for which there are only $3 billion of budget allocated,” resulting in a project finance shortfall of US$16 billion in 2009 just within the country’s gas sector, Abrar reported. Mir-Kazemi was also quoted by Platts adding that the National Iranian Oil Company (NIOC) currently only had ready available cash reserves of about US$103 million.

Iran has previously announced that it will look to the financial markets to raise project finance, as well as issuing sovereign debt, with Platts yesterday reporting that state-owned NIOC subsidiary Pars Oil and Gas Company (POGC)—the company tasked with overseeing the development of the South Pars reservoir—is preparing the issue of a 1-billion-euro (US$1.4-billion) bond. The Eurobond is hoped to finance some of the immediate development of the South Pars, which official Iranian sources recently estimated would require US$40 billion to be developed in full. That number is, however, likely including the stalled LNG export projects, which look impossible to move ahead under the current international sanctions and in any case might struggle to receive their gas feedstock allocations in a few years’ time if Iran’s domestic demand continues to spiral.

Given especially the unilateral U.S. financial sanctions imposed on Iran for its controversial nuclear programme—but also the multilateral UN restrictions—Iran’s ability to raise finance and for investors in Iran to transfer money in and out of the country have already been severely constrained. Even Chinese and Russian companies—initially eager to take the place of Western oil companies and sign memoranda for potentially lucrative contracts—have over the last two to three years showed themselves unwilling to commit financially by translating their memoranda of understanding into proper contracts.

Outlook and Implications

Iran’s gas consumption is continuing to spiral, throwing all its export ventures into question while in the short-to-medium term making it impossible for the country to meet domestic demand with its depleted upstream development budget. With gas consumption in Iran being 3.5 times higher than in Turkey and 10 times higher then in Japan per capita according to Mir-Kazemi and growth averaging 10% per year, new production policies conducive to the long-term health of reservoirs in the oil and gas fields have to be developed, Platts reported. These pressures, together with the inability to fund projects anywhere near meeting its demand, are likely to force reform of its subsidy system, although this will have to be carefully managed to avoid placing large parts of the Iranian population outside the electricity and heating market during the coldest part of the year.

The severe financial shortages throughout the Iranian gas sector are also likely to continue making it very vulnerable to any additional international sanctions. This might politically work in its favour, as the international community might be wary of imposing fuel sanctions on Iran if they look likely to be as taxing on the civilian population as the sanctions against Iraq during the 1990s. With fuel shortages developing in Iran in a few months’ time, likely resulting in rolling blackouts, the readiness to burden the Iranian society further might disappear. In any case, current sanctions have already largely stopped the inflow of capital and technology into its energy industry, significantly aggravating the problems that Iran has had in the making for decades.