Iran hobbles through the sanctions
The country faces tough times ahead, but remains confident of weathering the economic storm
In November 2018, the US administration issued waivers to eight countries to continue importing Iranian oil, albeit at reduced volumes. Two of them, South Korea and Japan, had previously cut purchases almost to zero, so this move amounted to putting oil back on the market, and contributed to that month's slump in prices. The US also gave a waiver to Iraq to continue buying Iranian electricity and gas, recognising that destabilising Iraq's economy again would not serve other interests.
In 2019, the US will return to tightening sanctions, and steadily seek to eliminate waivers. But the fact of granting them so far was a tacit admission that some countries, notably China, will continue buying Iranian oil at least around the pre-sanctions level. Given the generous discounts and payment terms on offer, India and Turkey will also try to maintain imports, if they can get round the practical problems of shipping, insurance and making payments, and shielding the buyers from American secondary sanctions.
Russia will assist Tehran in making sales, given its desire to blunt the edge of the US sanctions weapon, and to gain further control over oil supplies to key customers, such as China, India and South Korea. A Soviet-era trading vehicle, Promsyrioimport, has been used to transfer Iranian crude to the Assad regime in Syria, and something similar could be done for other markets.
Crude exports, which had dropped from 2.5mn bl/d in the first half of 2018 to 1.5-1.8mn bl/d by October, will stage a partial recovery before US pressure resumes. By May, they could be as low as 0.9mn bl/d, but more likely around 1.5mn bl/d. Exports will be volatile month-on-month, as buyers drop in and out, and as oil is delivered to or sold from floating storage and bonded warehouses. Iran's use of evasion tactics, switching off vessels' transponders and ship-to-ship transfers, clouds the issue, though US satellites are watching. Exports to Europe, and to America's East Asian allies Taiwan, Japan and South Korea, will virtually cease. The EU's "special purpose vehicle" may eventually be effective for humanitarian trade and for small and medium enterprises, but not for oil.
Sanctions will restore the Revolutionary Guards' influence on the energy sector
After some confusion following Total's sanctions-induced withdrawal, CNPC has now stepped up as operator of Phase 11 of the development of the super-giant South Pars gasfield. Qatar Petroleum's recent decision to boost its LNG expansion from three trains to four, taking it from 78mn t/yr of capacity today to 110mn t/yr by around 2023, will draw on the North Field, its name for the shared resource. This will heighten the urgency for Tehran to continue developing South Pars, where it only recently overtook Doha in total output. With a long line of other major gas projects, such as Kish and North Pars, making little progress, the sharp rise in gas output in 2016-17 will see a hiatus. Depending on how domestic demand evolves in a recession-hit economy, that could mean a repeat of cuts of supplies to Turkey in winter and to Iraq in summer.
Chinese firms, notably CNPC and Sinopec, will continue developing the Azadegan and Yadavaran fields, being Iran's only option, although it previously removed CNPC from South Azadegan and Iran LNG over slow progress. Russia's state firm Zarubezhneft handed responsibility for the Aban, West Paydar, Shadegan and Rag-e Sefid oilfields to a unit of Russia's oil ministry, and it remains unclear whether this will make progress.
Otherwise, Iran will again have to fall back on its own resources. Ironically, sanctions to some extent ease the task, since with reduced exports and production, the call on the mature fields can be reduced.
Decline rates in the mature fields such as Ahvaz, Gachsaran and Marun, contributing around two-thirds of Iranian production, are around 9pc annually without enhanced recovery efforts. So 3.8mn bl/d of crude capacity in 2018 would have fallen to about 3.57mn bl/d by the end of 2019, the drop having to be compensated for by development of the new West Karoun area and other fields. If, however, sanctions constrain 2019 production to average around 2.9mn bl/d (giving about 1.6-1.7mn bl/d of exports), end-2019 capacity may have fallen to about 3.65mn bl/d, comfortably above actual production.
But the restrictions also hamper Iran's access to finance, advanced technology and equipment, forcing it to pay inflated grey-market rates. Completion of a large number of petrochemical facilities, too, continues to be hampered. Local Iranian companies, including subsidiaries of the Revolutionary Guards, have succeeded in executing several phases of South Pars, albeit with lengthy delays, and have signed for a number of oilfield developments. Oil minister Bijan Zanganeh had been taking steps to reduce the Guards' influence on the energy sector, but sanctions will now restore their critical role.
The pressure the US can exert depends on developments in the oil market and politics. If prices continue their November tumble, Iran's revenues will be reduced, even if it manages to sustain exports. There will also be less incentive for its customers to take risks to realise discounts, and Russia will be less inclined to help. The domestic political pressure on Donald Trump over his Iran policy, revealed in a series of frantic anti-Opec tweets, would be reduced. The same would apply if a global economic contraction hit oil demand.
Should the Opec+ alliance seek to restore production cuts, Iran will not cooperate. Though practically there is not much it can do about this in the short term, it would give some comfort to others, notably Iraq, which might be inclined not to comply.
Conversely, if markets over-tighten as they did in mid-2018, the US may be more inclined to give further waivers. On the political front, a crisis elsewhere—perhaps involving Russia or the trade war with China—could distract the White House, and make it unwise to chance a simultaneous embroilment.
1.5mn bl/d—likely crude exports mid-May
If Iran continues to weather the sanctions reasonably well, and if European attempts, supported by China and Russia, to keep open alternative payment channels are successful, the government may be able to resist pressure to resume the full nuclear enrichment programme, hoping to wait out Trump and resume negotiations with a more tractable administration post-2020. Over time, as with the 1990s sanctions on Saddam Hussein's Iraq, compliance will wane, customers will develop ways to avoid the measures, and eventually the EU, China and Russia will progress on a financial system not reliant on the US. Tehran also feels it is on the winning side in the regional conflicts, with Assad regaining territory in Syria, Saudi Arabia under international pressure over its role in the war in Yemen, and some tentative signs of a resolution of the Saudi/UAE-led standoff with Qatar.
The economy, though, has serious structural weaknesses, including big holes in banks and state pension funds. If the sanctions trigger an economic crisis, hardliners might seek to resume full enrichment. Despite frequent and widespread protests, and the dreams of Washington hawks, the regime retains substantial resources and powers of coercion, and is not likely to collapse. It regards the "malign regional activities" for which the US castigates it as core to its national security, and the support for Assad, Hezbollah, the Houthis and a variety of Iraqi groups is anyway not that expensive.
Then the EU would be faced with the choice of trying to maintain its policy of engagement, or shifting back to the Obama-era cooperation with the US on sanctions. Even if Iran continues to comply with the Joint Comprehensive Plan Of Action, the failure of sanctions to force meaningful concessions from Tehran will present the US with a conundrum.
With few remaining economic or diplomatic tools, it would face the choice of simply continuing sanctions and containment, taking military action against Iranian nuclear and other sites, or seeking to confront Iran on regional battlefields. The White House, though, has shown no signs of developing any strategic approach to countering its adversary's international reach. Such an escalation would risk a major regional crisis and interruption to oil exports from Iran, Iraq and perhaps other countries.
Iran's long experience of sanctions gives it resilience. Despite severe economic and humanitarian pain for ordinary Iranians, that experience will enable the regime to cope with the US campaign. That in turn will contain the disruption to oil markets—unless the logic of deadlock leads the two sides into a deeper confrontation.
Robin M Mills is CEO of Qamar Energy and author of The Myth of the Oil Crisis