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The struggle to market

Iran has significant proved gas reserves and a long-held desire to become an influential exporter to world markets. But it will struggle to realise these ambitions, writes Alex Forbes

SINCE President Mahmoud Ahmadinejad came to power in mid-2005, Iran has rarely been out of the international spotlight. The issues have been many and varied: the self-styled hardliner's views on Israel and the US; Iran's nuclear ambitions, ostensibly for energy development; and most recently, of course, the tale of the UK military personnel who may or may not have strayed into Iranian waters (see p40).

Most of what has been published about Iranian energy has concerned the nation's nuclear ambitions and its tussles with the UN Security Council. Relatively little has been said about much-needed new initiatives in the oil and gas sectors – central to the future economic prosperity of Iran's 70 million people and to meeting demand from energy consumers around the world, particularly for natural gas.

In truth, there has been little positive news to report. What news there has been about the oil and gas sectors has concerned mainly delays, the abandoning of agreements and fruitless negotiations.

A show of defiance

Early 2007 saw a flurry of more positive news, but still nothing that could be considered a firm new development or export deal. Some observers viewed these positive developments – particularly a series of liquefied natural gas (LNG) announcements – as a political show of defiance, inspired by the president's office, in response to UN sanctions imposed at the end of 2006.

Iran is heavily dependent on oil and natural gas for export revenues and to meet domestic energy needs. So the development slow-down is worrisome – not just for countries hoping to source energy from Iran and for firms investing, or that hope to invest in the energy sector, but also for the Iranian people.

There are signs that the nuclear stand-off is taking a heavier toll on the economy than some Iranians are prepared to admit. Not surprisingly, Ahmadinejad is no longer as popular at home as he was.

In the case of oil, development is needed just to maintain production at about 4m barrels a day (b/d), let alone to reach the government's target of over 5 million b/d. As for gas, Iran needs to ramp up its already considerable production to meet growing domestic demand and to realise its export ambitions. At the start of 2007, Iran was forced to temporarily cut off pipeline exports to Turkey – and to some domestic customers – because cold weather sent domestic demand soaring.

Figures published by Opec show Iran's gross production in 2005 was 158bn cubic metres (cm), up by 5.7% on 149bn cm in 2004. Of this, 95bn cm was marketed, 28bn cm was re-injected to enhance oil production and 15bn cm was flared (see Table 1). The figure for marketed production makes it the world's sixth-largest producer. The figure for flaring prompted the World Bank to describe Iran as "the most significant flaring country" in the Middle East.

The scale of Iran's export ambitions was highlighted last year by Reza Kasaei Zadeh, the deputy oil minister and general director of National Iranian Gas Company (NIGC). He said Iran's policy was "to achieve 8-10% of the world's gas trade and its by-products within 20 years" He added: "It is estimated that by the end of 2010-2015, gas exports could reach 248.4bn cm/y, both as LNG and through pipelines."

He also questioned projections made for Iranian production and exports by the International Energy Agency (IEA). In 2005, the IEA forecast that, in a business-as-usual situation, production would grow to 110bn cm/y by 2010 and to 240bn cm/y by 2030. Exports were projected to reach 57bn cm/y by 2030.

The minister insisted Iranian production would rise to "157bn cm by 2010 and up to 340bn cm by 2040". Assuming he was referring to marketed and not gross output, this would require a rise of two-thirds over the 2005-10 period. But given how slowly Iranian energy developments are moving, the 2010 figure looks extremely optimistic; even the IEA's figure of 110bn cm by 2010 is looking a touch optimistic.

Interestingly, the minister's figure of 248.4bn cm by 2015 is similar to the upper limit Qatar has set itself under a moratorium on North Field output imposed in 2005 of around 260bn cm/y. The contrast with Qatar is significant on several levels.

Both nations have similar levels of proved reserves: Iran, with 27.58 trillion cm at the end of 2005, is the second-largest reserves holder after Russia; Qatar, in third place, has similar reserves to Iran. Moreover, the top three have reserves an order of magnitude larger than any other country – Saudi Arabia, in fourth place, has reserves of just 6.90 trillion cm.

Second, the two nations share a geological structure in the Mideast Gulf that is the world's largest resource of non-associated gas. The Qataris call their portion the North Field, while the Iranians call theirs South Pars. Iran sees Qatar as a rival in the production of gas from the South Pars/North Field structure. It is concerned that Qatar, ramping up production rapidly, could end up with more than its fair share of the reserves, as gas migrates from one part of the structure to the other.

Third, Qatar's population of just 0.85 million is only a little over 1% of Iran's. Most Qatari gas use is to power its burgeoning industrial base, while Iran has substantial and growing demand from all consuming sectors, including petrochemicals.

Zadeh's optimism recalls forecasts made in 2004 by the then managing director of National Iranian Gas Export Company (NIGEC), Rokneddin Javadi. At a conference in Tehran that generated considerable excitement, Javadi said Iran had set itself the target of exporting 64bn cm/y of gas by 2011. The target would require completion of up to four LNG complexes and several ambitious pipelines to diverse markets such as India, Europe, Kuwait and the UAE. Three years on, little progress has been made.

A net importer

To put these numbers into context, Iran's exports in 2005 were 4.7bn cm, according to Opec, while its imports were 5.2bn cm – in 2005 Iran was a net importer.

There are several reasons for Iran's lack of gas export progress. An obvious factor is the country's fraught international relations. In the 1990s, the US unilaterally imposed sanctions on investment in Iran and recently re-confirmed them. Today, tensions have risen to frightening levels because of concerns that Iran is trying to develop nuclear weapons. In December, after months of manoeuvring by the Iranians, the UN Security Council imposed sanctions. There is now the chilling spectre of military action by the US on Iranian nuclear installations.

Another factor has been Iran's system of buy-back contracts – unpopular with potential international oil company (IOC) investors and, ironically, with many Iranians. Consequently, gas and oil development projects have proceeded much more slowly than they could have. Moves are under way to improve the attractiveness of the buy-back system, but it remains to be seen how successful these will be against today's political backdrop.

A third reason is that Iran's most obvious pipeline gas markets present daunting hurdles – political ones in the case of Pakistan and India, and over-contracted supply in the case of Turkey.

But perhaps the most important factor is that Iran is a significant oil producer, the second-largest in Opec after Saudi Arabia. Its gas production is, therefore, used mostly at home, either to free up oil for export or to enhance oil recovery. Because the government is keen to substitute gas for oil in its energy market, gas accounts for over half of primary energy use and this proportion is expected to continue rising.

A large pipeline-construction programme is under way to build the kind of transmission grid needed in the country, both to deliver gas to domestic consumers and to the borders for proposed exports by pipeline.

According to NIGC, the number of Iranian cities using gas rose to 550 in 2005, from 379 in 2000. The company projects that 690 cities will be using gas by 2009. The total length of the distribution network in 2005 was 110,000 km and NIGC says this will rise to 125,000 km by 2009.

Optimistic outlook

However, NIGC tends to be optimistic. At a recent LNG conference in London, a spokesman said potential exports in the form of LNG were 13bn cm/y by 2009. As the nation has yet to begin construction of a liquefaction facility, which once begun would take at least three years to come on stream, this looks impossible.

The spokesman added that export potential by pipeline by 2009 is 77bn cm/y – another impossible number given the infrastructure (let alone the export contracts) that would be needed. Despite Iran's long-stated ambitions to become an important gas exporter, pipeline exports are almost negligible in the context of total production, and are more than offset by its imports.

Iran has several LNG projects under development, but despite years of negotiation, not one has yet reached final investment decision (FID), let alone begun construction. The country is, therefore, at least four years away from its first LNG exports – and probably much longer.

Of Iran's LNG plans (see Table 2), until recently only one was regarded as having a chance of reaching FID in the short term: Pars LNG, a joint venture of the National Iranian Oil Company, Total and Petronas.

However, at the International Oil Summit in Paris last month, the new chief executive officer of Total, Christophe de Margerie, raised doubts about even that project's viability. He outlined several concerns, most importantly the rocketing costs of construction. "The cost figures we have received are so high that compared with what we had in mind three years ago they have doubled," he told Petroleum Economist.

Part of the problem, he said, was the general state of the construction market, but the availability of contractors in Iran is also an issue. De Margerie said Total has lined up customers for the project's output, but the new cost estimates "mean we have to renew all of our agreements to cope with this size of investment".

Investment politics

Asked about the geopolitics of investment in Iran, he said Total could not afford to ignore the issues and was taking them into account: "If we consider the project is putting the company at too much risk we will take a decision to delay it."

There is also the question, not mentioned by De Margerie, of where Iran would source LNG technology. Most key components used in projects around the world are manufactured in the US. NIGC says it has been negotiating with European firms, including Linde and Technip, but it is hard to see either working closely with Iran until the political situation improves.

There has also been talk of developing gas-to-liquids (GTL) projects in Iran, but these ambitions are even more nebulous than the LNG proposals.

Several phases of the giant South Pars field have now entered production, and several more are under construction, but none of the gas production is earmarked for export. Output from the first 10 phases of South Pars is destined for the home market, either for marketing to final consumers or for re-injection. Future phases will be dedicated partly to exports, by pipeline, LNG and, perhaps, GTL.

Nonetheless, Iran is making so much money from oil that it arguably does not need gas-export revenues. Oil output has been rising for several years and the high prices have led to real GDP growth of 5-7% a year. Moreover, according to IEA analysis, gas has a higher value when used to enhance oil recovery rather than as exports of LNG to India (see Figure 1).

Consequently, some Iranians are opposed to export. There is an intense debate within political circles about the desirability or otherwise of such exports.

But in the long term, gas and condensate are set to become as important a source of revenue for Iran as crude oil. The country's gas reserves are extremely large; world demand is projected to rise rapidly over the coming two-and-a-half decades; and production is in decline in several other gas-producing regions. It can only be a matter of time.

But exports will inevitably come second to meeting domestic needs. These needs are being boosted by Iran's growing petrochemicals industry – it aims to double its capacity over the coming decade. This will increase the pressure to develop new production to provide the necessary feedstock.

In a 2006 report, the IMF noted the significant progress Iran had made during its Third Five-Year Development Plan (2000/01-2004/05). But it stressed that "many challenges lie ahead". Iran's economy remains heavily, and increasingly, dependent on oil and "demographic dynamics will put increasing pressure on the labour market in the coming years". In the short term, the economic outlook for Iran remains favourable. But in the medium to long term, the IMF's view is that "prospects look challenging".

Perhaps the biggest economic task for Iran will be to impart fresh momentum to oil and gas development at a time when it is becoming increasingly isolated from the international community. Given the latest forecasts for world energy demand in general, and gas demand in particular, it is in everyone's interest that Iran succeeds.

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