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Slower than thought

Politics, uncertainties over contract terms and physical constraints will cap the speed of Iranian oil’s revival

Iran's post-sanctions return to the global oil and gas market is not going as smoothly as optimists hoped it would. A London conference at which the terms for upstream investment contracts were to have been unveiled has been postponed. The politics look increasingly difficult, including parliamentary elections on 26 February that seem likely to extend conservative dominance. Investor qualms are deepening.

The government expects to increase output by 0.5m barrels a day in 2016 and at a minimum regain pre-sanctions capacity of around 3.8m b/d. Production in January rose by 80,000 b/d to 2.9m b/d, and has probably inched higher in February too. But these goals may be missed. The target-setting looks more like a pre-emptive bid for higher market share than a grounded, stress-tested plan of action. 

Certainly, Iran can raise exports quickly, thanks to large volumes of crude and condensates it retains in storage. Israeli maritime-data consultancy Windward put Iran’s floating-storage levels at 47.8m barrels at the end of January. Iran has also tucked away millions of barrels on Kharg Island. Shana, the state news agency, said in mid-February that exports had already reached 1.3m b/d; would hit 1.5m b/d by the end of the Iranian year on 20 March; and 2m b/d early in the new year. In 2012, before sanctions, Iran exported between 2.2m and 2.5m b/d. Thanks to deep discounts, it has already secured deals to ship 300,000 b/d of crude to Europe.

Nor does Iran seem likely to jump on the Venezuelan-inspired deal, struck in Doha on 16 February, that calls for Saudi Arabia, Russia and other big producers to “freeze” output at January levels. Tehran’s goal is to restore lost production. Mehdi Asali was quoted by local newspapers as saying it would be “illogical” to expect Iran to observe the deal.

Resources to rely on?

The revival of Iran’s productive capacity will be significant for the market, but go less quickly than the ministry hopes. Once existing storage has been drained – possibly meeting supplies of between 200,000 and 300,000 b/d in the second quarter – field increases will be more difficult. New and brownfield projects this year, both onshore and offshore, could conceivably add up to 300,000 b/d in an optimistic case. The net result is likely to leave Iranian production topping out at 3.3m b/d this year. Bigger rises, to 3.7m-3.8m b/d, would arrive by end-2017. 

New production will come on stream from two main quarters. First, and most important, will be the existing mature onshore fields that account for the bulk of Iran’s heavy crude. That brings the largest producing field, Ahwaz, back into focus. Apicorp, a pan-Arab bank, estimates Ahwaz was pumping about 0.56m b/d in 2015. At least another 250,000 b/d is expected from that field, though the extra barrels may only arrive after 2016. Smaller increments may come from increased gas injection at the mature Aghajari field. 

Other mature fields will take much longer to perk up – and need enhanced oil-recovery techniques – before they add serious volume to the total. Given depletion rates of 6-12% a year, any increases in mature fields will have to be significant to overcome organic drop off. Likewise, Iran’s declining offshore is unlikely to add the kind of short- term volumes that would make a difference in 2016.

More enticing are the new onshore fields in Khuzestan province, which share similar geology with the giant fields across the border in Iraq. This includes the West Karun area, which holds Azadegan North and South. When Iran sorts out its investment terms, this is where international oil companies (IOCs) will be keenest to spend money. But that is a medium-to-long term target: West Karun can only be expected to start adding significantly to supply by 2018-19, at the earliest. South Azadegan, in particular, could produce 0.6m b/d at its peak – but not soon. It will yield only around 30,000 b/d by end-2016. All told, West Karun’s contribution to supply by the end of the year will be around 150,000 b/d, we think. Put alongside declines elsewhere, this leaves net increases coming in at 300,000-350,000 b/d – significant for a market already sloshing with oil, but less than Iran would like.

Risk and uncertainty

The lack of clear contract terms still leaves IOCs cautious too, especially when broader political risks remain a factor. To keep the opening on track, Iran will have to meet the terms of the Joint Comprehensive Plan of Action (JCPOA) – the terms of its nuclear deal that include tight limits on uranium enrichment and other provisions, all verified by the International Atomic Energy Agency. Failure will bring back sanctions.

Moreover, despite the deal some significant bilateral American sanctions remain in force; enough to make access to financing still tricky. Fears of falling foul of the US are clearly on IOC minds. One senior lawyer representing oil companies says that while the US State Department might look kindly on foreign companies seeking business in Iran, the Department of Justice is still suspicious. That kind of confusion is bad for business. The US has also lumped Iran in with Iraq, and Sudan and Syria for new rules in its visa-waiver scheme. If you travel to one of these countries you’ll now need an interview at an American embassy before you step foot in the US again.

But the uncertainties over the new-model Iran petroleum contract (IPC) are most vexing. Its terms were to have been revealed in London in late February. That conference was scrapped, with Iranian officials saying the UK couldn’t get its act together to provide visas for Nioc executives. But others suspect divisions among senior Iranians over the IPC were to blame. Conservatives are said to feel the contract, which replaces the failed buy-back model that IOCs so despised, risks giving too much away to foreign investors. The changed terms will probably now have to wait for the new parliament to have its say.

Meanwhile, other questions are surfacing, including what Iran will do with its surging condensates output. Phases 15 and 16 of South Pars gasfield are now on stream, and several other phases (13 and 19, and 20-24) are scheduled to start up later this year. South Pars alone is responsible for 80% of Iran’s condensate production, which could double to 400,000 b/d by mid-year and reach 0.6m b/d in the second half of 2016.

Condensates are more difficult to place in the market than crude oil. Fereidun Fesharaki, chairman of consultancy FGE and an expert on Iran, points out that the country’s condensates are high in mercaptans, making processing more difficult. So Iran will have to price the condensates aggressively. This matters to the country’s crude oil-production targets, because to ramp up production from fields like Ahwaz Iran will need to make operational space in its brimming storage tanks.

That means finding buyers for condensates, as much as for crude oil. It points to the awkward reality for Iran as it seeks to restore its place among the world’s biggest oil exporters. Big production increases will depend as much on what happens beyond its borders as within them.

While Tehran could feasibly oversee a rise in output beyond 4m b/d in the next 18 months, placing the oil in the market might be even less straightforward. History and present uncertainties suggest Iran will err on the side of caution. Production will rise, but more slowly than the market first thought.

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