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Iran seeks energy allies as sanctions bite

Trump’s Iran sanctions target oil. But will all be lost or will Iran find investors in Russia and China?

With the imposition of full US sanctions on Iran imminent, high-profile investors, such as France's Total have already confirmed they won't be seeking waivers to continue their operations. Instead, the major will opt out of developing the supergiant South Pars gasfield.

This was one of the most anticipated projects after sanctions on Iran were lifted in 2015. Total won the contract to develop the field, but the venture is now touted to be taken over by the Chinese state-owned CNPC. The move could mark an important turn for Iran towards the east as European investors are pushed out.

The renewed sanctions will once again make it impossible for European firms to deal with Iran. Use of the US dollar in Iranian trade will block companies from using the US clearing system, essentially denying them access to the US economy.

"It's obvious that without sanctions, Iran would have a huge opportunity to develop its oil and gas reserves to a much greater extent," an employee from Linde, a natural gas services firm, told Petroleum Economist. "Many international oil and gas companies hoped that things were moving, or moving faster, [and now] the window of opportunity seems [to be] closing again."

Linde is one of many European companies that has been burned in the past from daring to deal with Iran. The company signed a deal to supply key gas-liquefaction technology, only to find that it couldn't receive payments as a result of US sanctions. The withdrawal of Linde, and now Total, add to a poor track record for European countries in Iran's oil and gas sector. Iran is increasingly portrayed in Europe as a no-go zone for risk-averse investors.

Initially, the European Union had suggested that it might seek to establish a blocking statute, which would protect EU companies from US sanctions. But the move would be tantamount to waging economic war on the US and is now considered to be unlikely. 

Investment hurdles

Trump's sanctions have arrived during a period of political uncertainty and in the context of a US-China trade war. Relations also remain sour between the US and Russia, the latter being a long-standing ally of Iran and partner in the Syria conflict. Both China and Russia have few reasons to hold back on Iranian investments. But since the US dollar plays such a key role in the global financial system, the banking logistics associated with structuring an Iranian deal could still be a potential threat to investment.

Already, Russia has committed itself to a $50bn package of investments in Iran's energy sector. But many of the projects await definition. Industry insiders have cast doubt on when and if such upstream deals will go ahead.

"Currently most if not all oil and gas companies in Europe and even Asia are reluctant to get too close to Iran," says Fereydoun Barkeshli, former advisor to National Iranian Oil Company. "They talk, they sign MOUs, but in real life don't come forward to put money on the table." 

A shortage of domestic expertise is a latent concern for the Iranian energy sector. During Mahmoud Ahmedinejad's presidency and the years following, many Iranians moved to other countries, causing an extensive brain drain, particularly in the energy sector. Iran is struggling to address this legacy, while also facing difficulties acquiring the technology for rebuilding the energy sector. Certain technologies, such as liquefaction-processing equipment, are patented by Western companies, meaning it would be difficult for Iran to replicate them.

China and Russia have few reasons to hold back on Iranian investments

With a wealth of natural resources and key areas of infrastructure areas in Iran's own market that aren't fully developed, there are opportunities for domestic companies if money and expertise can be found. But aside from the logistical challenges, many of the oil reservoirs are aging. Around 50% of Iran's total oil supply comes from the four largest fields, with an average age of around 60-70 years, meaning they're relatively mature. As a result of being cut off from the global energy stage, Iran has used conventional techniques to recover the oil and this has caused some permanent damage to the structural integrity of the fields. 

Oil market impact

With Iran's volumes off limits for European and US buyers, the market has struggled to price in the weight of Iranian sanctions against fears of a US economic slowdown-the result of the US-China trade war. It's estimated that around 1m barrels a day of Iranian production could be lost through sanctions. But Opec members Saudi Arabia, Kuwait and the UAE, and non-Opec Russia are expected to cover the supply shortfall.

Spelling good news for China, Iran is likely to slash prices for its crude, meaning Chinese buyers will be poised to pick up oil at competitive rates. Chinese imports of Iranian oil have increased by around 3% in the past three months.

The Trump administration says it won't grant any waivers for companies buying crude from Iran. Under Obama, certain US allies were given leeway if they showed they were reducing imports-those countries included South Korea, Japan, India, and China. However, the sanctions still pose complications related to insurance and transportation of cargoes.

"In order to hedge risk [Indian companies] rely on Western insurers who're not insuring Iranian oil at the moment," says Justin Dargin, Middle East energy expert at the University of Oxford.

Some alternatives to trading in dollars exist, such as bartering deals that could enable oil to be exchanged for food or other commodities. Iran has already begun reaching out to non-European companies, such as refiner Indian Oil Corporation. It's offering them extra measures that would enable them to continue working with Iran by shipping oil cargoes on the huge Iranian tanker fleet and insuring them through Iran. In the past, Indian companies have avoided sanctions by paying Iran through a Turkish bank, using euros instead of dollars.

The sanctions will provide Iran with a strong incentive to focus its trading strategy on creating attractive prices for Asian buyers. Japan has said it will seek a waiver for Iranian oil on the grounds of energy security, but it's still likely that it will be forced to slow its imports.

Future focus

Aside from South Pars, a consortium comprised of Russia's Zarubezhneft and Iran's Dana Gas services firm signed a $742m deal earlier this year to develop the energy sector. While the capex isn't high in relative terms, these types of deals with Russia and China are likely to be Iran's best way forward during sanctions.

Iran may choose to focus its efforts away from the oil sector and begin diversifying or upping investment in other commodities. Natural gas faces many of the same crossover issues related to oil, including a lack of expertise and a blockage from many of the main demand markets. But the petrochemicals industry could be an attractive prospect and has the added benefit of being less volatile than the oil sector.

Moving forward, the main sticking points will be the lack of expertise available from non-Western companies. This could both stymie and slow investment, meaning Iran's dreams of returning to the global stage in a big way are, for now, far from reality.

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