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Iran’s oil hopes may hinge on Vienna outcome

The fate of Iran and the sanctions against its oil sector is a wildcard facing Opec as it tries to balance the market. Meetings in the Austrian capital this month should make the picture clearer

The fate of an oil industry over a century old can turn on the events of a few weeks. When negotiators from the P5+1 group (the UN Security Council plus Germany) reached a temporary accord with Iran on 24 July, the Brent oil price was $108 a barrel. The implications of the fall of Mosul to Islamic State (IS) on the night of 9 June were still being digested.

Events have developed in ways both favourable and unfavourable to Iran. Oil prices have fallen sharply, with Brent now below $90/b. US production continues to surge, demand is tepid, and Iraqi and Libyan exports picked up in September. Iranian oil minister Bijan Zanganeh has decided not to call for an emergency Opec meeting before the next scheduled event on 27 November. The regular meeting will fall just after the expiry of the interim nuclear deal, and the latest deadline for a final agreement.

Lower oil prices put more pressure on Iran’s shaky economy. With the mismanagement of the administration of previous president Mahmoud Ahmadinejad, oil output was already slipping. Under the impact of sanctions, crude production has fallen from 3.5 million-3.6m barrels per day (b/d) during 2011 to 2.77m b/d in August 2014, plus another 0.8-9m b/d of condensate and natural gas liquids. With internal consumption at around 2m b/d, this equates to 1.5m b/d of petroleum exports, of which 1m b/d is crude oil. Production has been essentially flat during 2014, albeit slightly up on 2013.

Even while oil prices remained strong, Iran’s oil export revenues dropped from $115bn in 2011 to $62bn in 2013. This could well be less than $50bn in 2015, if oil prices do not recover from the recent slump.

On the other hand, Iran’s political position has improved, with its support essential for formation of the new Iraqi government, and Iranian advisors on the ground to support the Iraqi army and Iranian-backed militias in the fight against IS. Nuclear negotiators from the West have sought to stress that their task is entirely separate from any cooperation to fight IS, while Iranian President Hassan Rouhani and his team have hinted at a tacit bargain.

Despite sanctions, Iran has not been overtly discounting crude to Asia – with official prices at a slight premium to Saudi grades, and considerably above Iraq’s. It has, though, been offering laxer payment terms, and this is complicated by the payment freeze on Iranian shipments – with revenues locked up in the importers’ banks, and only available to pay for Iran’s imports from that country. As part of the July interim sanctions deal, Iran gained access to limited amounts of these oil revenues.

Bold output targets

On 24 November, the latest deadline for negotiations on Iran’s nuclear programme, three broad outcomes are possible.
In the first case – looking increasingly out of reach for now – a comprehensive agreement will be reached, in which Iran restricts its nuclear enrichment and related activities and submits to further international inspections, and in return sanctions on its oil and other sectors are progressively lifted.

Iran’s target is to recover from sanctions-induced losses and increase output even beyond pre-sanctions levels, to around 4.5 million b/d in 2019. With an increase in condensate and NGL output of 1.2m b/d (mostly from the South Pars field), overall petroleum liquids production would reach 5.7m b/d.

This target, although not ultimately impossible, is highly optimistic in that timeframe. With natural decline in mature fields running at 7% annually, reduced production due to sanctions has actually eased the strain on the fields. However, today’s production capacity is probably down to around 3.2m b/d of crude oil, and could increase to 3.4m-3.6m b/d within a few months, given some remedial work.

To take output beyond this will require major development of new super-giant fields, such as Azadegan and Yadavaran, as well as small- and medium-sized fields, plus improved and enhanced oil recovery (mostly via gas injection) in the mature fields. It will be difficult for this, plus plans to raise gas (and associated liquid) production by almost 50%, to make much impact before the end of the decade.

These plans cannot be achieved without major international investment and technology. Iran’s new petroleum contract appears much more favourable than its infamous buyback terms of the late 1990s, but it will inevitably take time to negotiate and implement. Sanctions will not be lifted all at once, even if companies such as Total and Eni are clearly keen to return.

Nevertheless, the speedy return to the market of 1m b/d of Iranian crude would be a problem to other Opec members. Iraq, planning its own major output gains albeit with great security and logistical challenges, would face competition for very similar crude grades and markets, mostly in Asia. Saudi Arabia and its close Gulf allies would have to consider whether to challenge Iran – noting Zanganeh’s earlier comments that Iran would regain its market share even if oil prices were to fall to $20/b – or to accommodate their political adversary by reducing their own output. Renewed upsets in Libya, a squeeze on US shale-oil output from lower prices, a global economic recovery are all possible – but both Iran and its Opec rivals need hard-headed calculation, not dreamy gambling.

Limping along

In the second case – probably the most likely – there is sufficient progress on talks to justify further discussions. However, given the political pressures on both sides, further extensions will prove increasingly difficult and give more ammunition to hardliners. The US would be likely to tighten sanctions, and Iranian production would limp along around present levels. This situation might persist indefinitely, with Iran seeking to find loopholes in sanctions and the US seeking just as energetically to close them. Lower prices and an oversupplied market make it simultaneously more urgent and harder for Iran to secure buyers. Eventually – and probably during 2015 – this state of quantum uncertainty will have to resolve into a comprehensive deal or a collapse of talks.

In the third case, the talks fail entirely – even if they stagger on zombie-like for appearance’s sake. It is highly unlikely that this will trigger a US or Israeli military attack on Iran’s nuclear facilities – the US has its hands full dealing with IS in northern Iraq and Syria, where it needs Iranian cooperation. But domestic political pressure would mean that intensified sanctions would be introduced. The effect would depend on whether the US or Iran were seen as primarily responsible for the failure of talks – and whether China or Russia were to take the chance at challenging the sanctions more overtly.

Indicatively, this might cut Iranian exports by 0.5m b/d in 2015, but they would then recover slowly as sanctions enforcement slipped, regaining 2014 levels by 2017-18. After that, field depletion and underinvestment would take its toll, and Iranian production would slowly decline, to 2.5 million b/d by 2020, that is, down some 1m b/d on immediate pre-sanctions levels. This would significantly ease pressure on Iran’s Opec peers, notably Saudi Arabia.

Iran is thus one of the three wildcards – with Libya and Iraq – that can ease or complicate the task of Saudi Arabia and its Gulf allies in balancing Opec output. As the past month has shown, that task was already tricky. Not just one, but two important gatherings for Opec – its own November meeting, and next week’s P5+1 nuclear talks – are on the schedule for this Congress of Vienna.

Robin Mills is head of consulting at Manaar Energy and author of The Myth of the Oil Crisis

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