Iran feels the pressure of sanctions and self-inflicted problems
More sanctions make life harder for Iran. But its own disastrous economic management might have worse consequences, write Tom Nicholls and Simon Crompton
WITHIN a fortnight of the US' latest – toughened – sanctions against Iran, Russia was broadcasting plans for a deepening of its energy relationship with the country. And Chinese traders were helping short-circuit Western efforts to throttle Iran's energy sector by supplying the country with gasoline.
The division between West and East over what sanctions to apply against Iran in response to its refusal to stop enriching uranium had been evident since 9 June, when the UN' Security Council passed its fourth set of sanctions, building on measures introduced in 2006, 2007 and 2008. China and Russia endorsed the UN sanctions – which tighten financial restrictions between Iranian banks and the international community, broaden the arms embargo and blacklist some companies linked to Iran's Islamic Revolutionary Guard – but insisted on the removal of measures targeting Iran's energy sector.
This prompted the US and the EU to introduce their own, tougher measures. On 1 July, the US – which first imposed sanctions against Iran in 1979 – broadened the scope of its existing sanctions to enable it to bar non-US companies selling refined products to Iran or investing in the country's oil and gas sector from doing business with US companies and financial institutions. The EU, meanwhile, has agreed to sanctions that ban new investment, technical assistance and technology transfers relating to Iran's gas and oil sector – in particular refining and liquefied natural gas (LNG) technology. EU sanctions also target the transportation sector, including shipping and air travel.
Hit where it hurts
Disrupting gasoline imports should hurt Iran. Short on refining capacity, the country imports 130,000 barrels a day (b/d), or about 40%, of its gasoline needs, so it will struggle to meet local demand. Total – which provided a third of Iran's gasoline imports in May – Shell, BP, Reliance, Glencore, Petronas and Lukoil have all stopped supplying gasoline to Iran.
Some countries in the Middle East will be tempted to help fill the gap because of the premium they will be able to charge, but they will be under considerable political pressure not to do so. There is already some evidence that UN sanctions are having the desired effect on Iran's regional trading partners. In June, the UAE's central bank told financial institutions in the country to freeze 41 Iran-linked accounts.
"This was a big move," says Mehdi Varzi, an oil consultant and a former employee of National Iranian Oil Company (NIOC) and the Iranian foreign ministry. "Previously, the UAE paid lip service to sanctions." Iran uses the UAE as a channel for funds for the oil and gas industry, he points out, so greater compliance on the part of the UAE will make it more difficult for Iran to source products and harder for services companies to work with Iran. "Officials will have to walk around with cash in their pockets." As a result, Iran is likely to become more reliant on Chinese companies to sustain its oil industry. China's Unipec and ChinaOil both supplied Iran with oil products in April.
US sanctions will not only have a "material impact" in the near term by curtailing fuel imports, but will also hamper progress with oil and gas developments in the long term, says the International Energy Agency (IEA). Gas and natural gas liquids (NGLs) projects will be hardest hit, it says. In June, the agency forecast Iran's production capacity of NGLs and condensates would expand from around 0.52m b/d in 2009 to just over 1.0m b/d by 2015, but the additional constraints on procuring equipment and materials that will arise from sanctions "increase the downside risk" to that forecast.
Part of Iran's problem is the steady exodus by Western firms from its oil and gas sector, which had begun in anticipation of tighter sanctions. In April, Italy's Eni said it would cease operations on the Darkhovin (or Darquain) oilfield. Shell and Repsol pulled out of development of phases 13 and 14 of South Pars in June after eight years of negotiations.
Russian and Chinese companies may partly fill the vacuum, although they lack some of the technology that Western companies are able to offer. Russia's agreement with Iran, which stretches across the oil, natural gas and petrochemicals industries, envisages the formation of a joint-venture oil company and a joint bank to finance oil projects. And Russian energy minister Sergei Shmatko has also said that Russian companies would be prepared to deliver oil products to Iran "if there is a commercial interest".
The timing of Russia's announcement reflects the depth of the division within the Security Council and gives some succour to Iran, although grandiose intergovernmental plans for energy co-operation do not always live up to their billing. Russia's Gazprom Neft is scheduled to complete talks this summer on plans to develop the 2bn barrel Anaran oilfield and on a November memorandum of understanding to study the Azar and Shangule fields. But the state-controlled firm has also said any deal would depend on the UN changing its trade sanctions on Iran – sending out a conflicting message about Russia's intentions.
China's strategic view
Meanwhile, China's refusal to endorse the inclusion of measures targeting Iran's energy sector reflects the strategic view it has taken of energy investments in the country, which has offered improved investment terms to Chinese energy companies; Iran granted China National Petroleum Corporation (CNPC) shorter payback periods and higher rates of return in 2007 in the 6bn barrel Azadegan project. The agreement commits CNPC to investments of about $1.76bn. Sinopec's 2009 agreement to develop the Yadavaran field, which could hold up to 18bn barrels and will result in estimated investments of $2bn, also featured better terms than foreign investors have traditionally enjoyed. Since April, China National Offshore Oil Corporation (CNOOC) and Sinopec have been negotiating to replace Eni at Darkhovin, NIOC says.
In addition, since the sanctions, Iran has redoubled efforts to attract Chinese investment. In early July, Iranian officials travelled to Beijing to brief Sinopec, PetroChina and CNOOC on opportunities in the country. Hossein Noghrekar Shirazi, head of refining at NIOC, was quoted by a Chinese newspaper as saying investors would enjoy policy sweeteners such as a 5% discount on raw materials purchased in Iran and an eight-year tax break for investments made in its free-trade zones.
However, while existing projects mean Chinese companies will invest several billion dollars over the next few years, investment is unlikely to reach the $25bn a year that Masoud Mir-Kazemi, Iran's oil minister, says the oil sector requires to halt its decline. The UN sanctions "will certainly step up pressure on non-Western companies involved in Iran", says David Kirsch, an analyst at PFC Energy, a consultancy. "While some might pull out, the biggest effect will be a lack of appetite for new projects," says Kirsch, an ex-employee of the US state department, where he was involved with the implementation of the US' 1996 Iran-Libya Sanctions Act. Indeed, Chinese investors have rarely proceeded further than the signing of non-binding initial deals. Yadavaran and Azadegan are the exceptions.
Any hope that Iran might be bailed out by investors from other parts of Asia may also be overly optimistic. South Korea's GS Engineering was quick to pull out of its Iranian operations following the sanctions. In July, it cancelled a $1.2bn project to sweeten gas from South Pars as part of phases six to eight of the field development. The contract had been arranged in 2009 with Pars Oil and Gas (part of NIOC) and was scheduled for completion by April 2013. GS had been supplying technology for gas-processing plants and its exit will remove much-needed technical expertise from the country. Iran also needs partners to help it build cracking or coking units at its refineries to increase their gasoline yield. And its dreams of leveraging the world's second-largest gas reserves to become an LNG exporter seem further away than ever.
The brain drain will prove especially costly for Iran given the politicisation of NIOC, its subsidiaries and numerous local services companies under President Mahmoud Ahmadinejad, a process that has accelerated since his dubious election victory last year. Experienced managers have been forced to retire to make way for political loyalists, with costly operational consequences. Companies affiliated to the Revolutionary Guard have been handed control of projects left vacant by the departure of Western firms. Khatam al-Anbiya, for example, was awarded the development of phases 13 and 14 of South Pars when Shell and Repsol left. It is already contracted to complete phases 15 and 16 and plans to take on phases 22 and 24 from Turkish Petroleum International, which pulled out of its $7bn investment earlier this year.
More attractive alternatives
This has occasionally frustrated Chinese investors and – with other projects around the world to choose from – the country's energy companies may avoid Iran and its mounting organisational problems. Says Varzi: "The Chinese will likely continue with existing projects, but won't take on anything new. Investment in Africa and Iraq will look far more attractive."
Indeed, Iran has – arguably – bigger self-inflicted problems than sanctions, mainly stemming from political meddling and poor economic governance. The oil industry, which contributes half of the government's revenues, is badly underperforming: maturing oil fields are experiencing decline rates of about 8-10% a year. The IEA estimates Iran's output capacity at 3.96m b/d, below the 4.1m b/d the country claims, and forecasts a fall of 0.675m b/d by the end of 2015 to about 3.3m b/d.
While avoidable failures in Iran's oil sector are causing serious financial damage, there are plenty of other signs of economic decay, including public-sector shut-downs, strikes and failing public services. As the situation deteriorates, the risk of public unrest will rise and it may accelerate if the government follows through with its plan to reduce fuel subsidies from September.
Disastrous economic management has the potential to send Iran hurtling towards economic oblivion more quickly than sanctions – especially if it deters investment from the few friends the country has left.
Iran sanctions explained
Passed on 9 June, UN Resolution 1929 recalled and replaced the previous three rounds of UN sanctions against Iran – passed in 2006, 2007 and 2008. Previous rounds had gradually increased the restrictions on individuals or businesses linked to Iran's nuclear programme, freezing assets and blocking trade. Each also ordered Iran to stop uranium enrichment, which it ignored. The new sanctions added rules that:
Threatened new Iranian banks abroad if they were suspected of involvement with the nuclear programme
Instructed banks around the world to be vigilant against actions by any Iranian bank, including the central bank
Expanded the arms embargo
Blacklisted 18 Iranian shipping firms and called for a cargo inspection regime similar to the one imposed on North Korea
Blacklisted 40 other Iranian companies
The US has had sanctions against Iran since 1979. Most US-Iran trade was banned. In 1995, US companies were banned from investing in Iran and oil or gas trading with Iran. Congress also banned foreign firms from investing more than $20m a year in Iran's energy sector, although none have ever been prosecuted. Three banks – Bank Melli, Bank Mellat and Bank Sedarat – received specific sanctions in 2007. On 24 June, the US passed new sanctions that:
Banned companies that supply Iran with refined oil products from US contracts and the US financial system
Sanctioned foreign banks that work with Iran's Revolutionary Guard, support its nuclear programme or what Washington calls Iran's terrorist activity. These banks would also be denied access to the US financial system
Sanctioned specific Iranian firms and individuals, including Iran's Post Bank, its defence minister and the air force and missile command of the Revolutionary Guard
The EU has imposed visa bans on senior officials in Iran linked to its nuclear programme, but never previously imposed unilateral sanctions. The UK had cut business ties with Bank Mellat and Islamic shipping in October 2009. The EU passed sanctions on 17 June that:
Banned investment, technical assistance and technology transfers to Iran's oil and gas industry, in particular refining and liquefied natural gas, by European companies
Banned Iranian shipping and air cargo companies from operating in EU territory
Introduced new visa bans
Froze assets belonging to members of Iran's Revolutionary Guard