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Iran - the great return: part two

Iran's energy sector is making progress, but political threats are lingering

After years of struggle and stasis, Iran's energy sector enjoyed a strong 2016 and should start 2017 with optimism.

Following the lifting of sanctions, oil production and exports have been restored, creating a platform for much-needed international investment. But political and practical uncertainties inside and outside the country must be resolved before investment deals can really start to flow.

Oil production rose above 3.6m barrels a day in the second half of 2016, compared with 2.8m b/d for most of 2015. The country boosted exports to its Asian customers, and regained market share in Greece and Italy. Iran has demanded an increase in its Opec production ceiling to 4m-4.2m b/d, its negotiators emboldened by the encouraging outlook for the economy; the IMF, expects Iran to outperform the rest of the Middle East in 2017, with growth, accelerating to 4.1%, from 4.0% in 2016.

But even if Opec were to approve Iran's request getting there in the near term would seem a stretch. Production growth largely petered out after May.

In the long term, opportunities for more upstream growth abound and progress has been made in developing Iran's next generation of fields in the West Karun area, towards the Iraqi border. Fields include Azadegan, Yadavaran - where China's Sinopec has been working - and Yaran. The plan is to boost output from West Karun to 0.6m-0.7m b/d by 2017-18, from 250,000 b/d at present. But those expected gains will largely be offset by declines at older fields.

After protracted discussions, parliament has approved the new Iran Petroleum Contract (IPC). The new terms are a big improvement and allow international oil companies (IOCs) long-term involvement, flexibility in development, and the potential for reasonable returns as long as remuneration fees are high enough.

The first IPC deal was signed in October with Persia Oil & Gas, a subsidiary of Setad, a large and opaque investment vehicle controlled by Supreme Leader Ali Khamenei. The $2.2bn project involves raising production at the Kupal, Marun and Yaran fields from 185,000 b/d to 260,000 b/d. Western companies are unlikely to cooperate with Setad and the contract does not bring extra finance into Iran. But the arrangement has the domestic political aim of defusing hardline opposition to the IPC. State company Nioc wants another two or three contracts signed by 20 March 2017 but no final deals with overseas companies have yet been concluded and IOCs may get frustrated by the slow pace.

Arrangements with IOCs, so far, involve only upstream studies: Total at the South Azadegan field; Indonesia's Pertamina at the Mansouri and Ab Teymour fields, west of Ahvaz, an oil-hub city; Eni at Darquain; and Russia's Lukoil and Gazprom Neft at the Azar and Changuleh fields (Azar is the continuation of Gazprom Neft-operated Badra in Iraq). Shell has previously worked on Yadavaran, which forms part of the same structure as the Majnoon field it operates in Iraq. Other studies include Russia's Zarubezhneft at the West Paydar heavy oil-field, Austria's OMV at the Band-e Karkheh and Cheshmeh Khosh fields, and Germany's Wintershall at four fields in western Iran.

Iran has also advanced in domestic natural gas production, with long-delayed phases of its giant South Pars field finally coming on stream. National output rose by almost 6% in 2015, reaching 192bn cubic metres of processed gas, making Iran the world's third-largest producer. Further increases will come, with the completion of South Pars Phase 19. By 2017, Iran expects extraction from South Pars will have bested Qatar's output from the North Field, the continuation of South Pars on the Qatari side.

But most of Iran's exports still only go to Turkey. It still imports gas from Turkmenistan. And industrial gas demand could surge yet again if Iran attracts sufficient investment to complete various stalled petrochemical facilities.

So more gasfield development will be needed to meet domestic demand and provide a surplus for export. Negotiations continue with India's ONGC for development of the offshore Farzad-B gasfield, to produce up to 20bn cm a year, some of which could feed a liquefied natural gas facility. A total of 21 gasfields, both onshore and offshore, have been included in an initial list of projects for investment from the oil ministry.

Aside from sending more gas to Turkey, Iran's likeliest near-term markets are Iraq, Pakistan and Oman. The commissioning of a pipeline to Iraq's volatile Diyala province has been held up by violence, but exports are expected to start soon. Pakistan hopes to begin imports of Iranian gas by 2018, through a pipeline that already runs nearly to the border. Plans to export gas via a subsea pipeline to Oman continue to progress, with the line being re-routed to avoid UAE waters.

More speculatively, prospects exist too. South Asia Gas Enterprise hopes to build a subsea pipeline to India that avoids Pakistan. A private Norwegian company, Hemla, is seeking financing for a project to produce LNG from flared gas around Kharg Island in the northern Persian Gulf. But large new greenfield LNG plants in Iran, on the drawing board for years, seem unlikely in the depressed global market. And Iran needs to avoid its errors of the early 2000s, when indecision over how best to use its gas led to it missing opportunities to export and gave it a reputation as an unreliable supplier.

Political clouds hang over the country's energy sector. Donald Trump may harden the US' stance on Iran. And while President Rouhani looks likely to win re-election in May - no sitting Iranian president has been defeated - he still faces hardline opposition and discontent over the slow pace of economic recovery.

IOCs considering investing may hold back until they know who they will be dealing with in Tehran and what Washington's position will be.

The turbulent political landscape in the region could bring more pressure on Iran, which is still strongly backing the Assad regime in Syria both directly and, in the form of Hezbollah, via proxy. It has also backed Houthi forces against Saudi and Emirati intervention in Yemen's civil war. Tehran's closer alignment with Moscow has also led to some domestic disquiet, given the long history of suspicion between the two countries.

The Iranian energy sector needs to attract an extraordinary amount of investment: some $0.5 trillion across all sectors over the next decade, most of which will have to come from foreign sources.

But Iran's banking system needs recapitalisation and bail-outs, while international banks are still wary of US sanctions. Other sources, such as Chinese and mid-tier European banks, diaspora capital, and export-credit agencies will have to play a role.

Businesses linked to the Revolutionary Guards spread their influence across the energy sector under Mahmoud Ahmadinejad's rule and the Guards' engineering unit, Khatam Ol Anbia, remains an approved partner for upstream projects. The terms of the IPC require non-Iranian investors to form joint ventures with Iranian companies, and IOCs will need to screen partners carefully for links to sanctioned entities.

The recent arrest of several dual nationals, including oil executive Siamak Namazi, has sent a negative signal to foreign and expatriate investors.

The easier work of restoring oil output has been largely accomplished. Iran has finally succeeded in boosting gas production too.

But in 2017, Iran must attempt the trickier task of attracting international investors, despite residual sanctions, as well as capable domestic companies to develop new fields and sustain mature ones. Tehran's energy riches cannot afford more domestic infighting.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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