Iran is the perennial “elephant in the room” of international gas trade. The country could well become, one day, a major game changer of international gas markets but today its potential still remains fundamentally untapped due to a number of geopolitical and commercial reasons. Iran owns the first largest proven gas reserves in the world, but since 1997 it is basically a net-importer of gas. This paradoxical situation is due to a number of internal and external factors, the main of which relates to the international isolation of the country due to the well-known international dispute over its nuclear program. For this reason, if the positive outcome of the recent nuclear talks turns into a complete nuclear deal, great opportunities will likely open up in Iran also with regard to the gas market. The aim of this article is to analyze the country’s gas outlook in the aftermath of a potential nuclear deal, looking at the potential production trends, at the potential export options, but also at the political and commercial barriers that such a development will likely have to face. In fact, a full resolution of the nuclear issue will unlikely automatically change the Iranian gas market in the short term, as a number of commercial issues will continue to remain on the table. In other words, the “elephant” will need a bit of time to move. However, it is sure that its movement will ultimately have a profound and long-lasting impact on international gas markets.
Keywords: Iran gas market, International gas markets, World energy outlook, Nuclear talks
JEL classification: Q40, Q42, Q4
Suggested citation: Tagliapietra, Simone, The Future of Iran's Gas Market after the (potential) Nuclear Deal (March 20, 2014). Review of Environment, Energy and Economics (Re3), http://dx.doi.org/10.7711/feemre3.2014.03.002
See other useful links
Iran is the perennial “elephant in the room” of international gas trade, a country which could, one day, become a major game changer of international gas markets but the potential of which still remains today fundamentally untapped due to a number of geopolitical and commercial reasons. Among the others, the main reason of the current under-exploitation of Iran’s natural gas resources is clearly linked to the difficult political relations evolved over the last decades between the country and the West. However, the history of international relations has shown several times that relations between major actors in the international system could rapidly shift if the political willingness to do so is there. As a matter of fact, the presidents of the US and Iran talked for the first time since 1979 when Barack Obama called Hassan Rouhani on September 27, 2013 -when the Iranian leader was heading to the JFK airport in New York after having addressed the UN General Assembly. Moreover, after years of frustration and impasse in negotiations between Iran and six world powers (the five permanent members of the UN Security Council plus Germany, known as the P5+1), an interim deal on the Iranian nuclear program was finally reached in Geneva on November 24, 2013. This occurrence certainly represented just a first step toward a truly complete resolution of the Iranian nuclear issue, but it could be seen as a positive sign for the future. If these recent developments have a resolutive follow up, great opportunities could open up in Iran, also with regard to the natural gas sector.
Considering the world-class size of the country’s natural gas reserves, such a shift could well make Iran a real game-changer of international gas markets. In order to fully understand this potential the article will present an analysis of Iran’s natural gas market fundamentals, focusing on the reserves, on the current levels of production and consumption, and on the current trade dynamics. Consequently, the article will widely discuss the main commercial and political barriers to the development of the country’s natural gas market, such as the country’s petroleum legal framework, the country’s system of energy subsidies and the international sanctions affecting the country. Finally, the article will present an outlook of Iran’s natural gas market in the aftermath of a potential nuclear deal, discussing both the prospects for the domestic market and the various export opportunities, but always taking into account the commercial issues that will need to be resolved in order to allow a sustainable development of the country’s natural gas resources.
Iran's Gas Market: Reserves, Production, Consumption, Trade
Iran owns the first largest proven natural gas reserves in the world, estimated at 33.6 trillion cubic metres (Tcm). Eighty percent of Iranian natural gas reserves are located in non-associated fields, and most of these reserves have not been developed yet.
Figure 1 - Major proven natural gas reserves in the world (2012)
Source: own elaboration on British Petroleum (2013).
Iran’s natural gas reserves are predominantly located in the offshore Persian Gulf, although significant associated natural gas production originates from the country’s onshore oil fields. The three major natural gas fields in the country are South Pars, North Pars and Kish.
In terms of natural gas production, Iran ranks as third natural gas producing country in the world after the US and Russia, but its production level remains far behind its potential. In fact, in 2012 Iran produced 160 Bcm of natural gas, while the US produced 680 Bcm and Russia produced 590 Bcm. This figure is mainly due to the fact that Iran first began producing natural gas over 30 years ago, but it failed to institute an organised development plan until the late 1990s. Over the last two decades natural gas production has increased at a rapid rate in the country, but the international sanctions progressively imposed on the country -among other factors that will be widely discussed in the second section of the paper- considerably decelerated Iran’s natural gas production outlook.
Figure 2 - Major natural gas producing countries in the world (2012)
In terms of natural gas consumption, Iran consumed 156 Bcm in 2012: a level almost equal to its natural gas production. Furthermore, Iran’s domestic natural gas consumption is expected to grow around 7 percent annually over the next decade. This figure represents a tangible threat to Iran’s natural gas market, as the potential for shortfalls in natural gas supply will increase as domestic natural gas consumption will continue to grow and domestic natural gas projects will continue to face delays.
This threat is based on the precarious equilibrium on which the Iranian natural gas market has developed over the last decades. In fact, since the 1990s Iran’s natural gas production has basically equalled the country’s natural gas consumption.
Figure 3 - Iran’s natural gas production and consumption (1990-2012)
Notwithstanding this precarious equilibrium, over the last decades Iran committed itself to export natural gas to Turkey, Armenia and Azerbaijan. Turkey receives approximately 20 percent of its natural gas imports from Iran, making Iran Turkey’s second largest source of natural gas imports after Russia, which has about a 60 percent share of Turkey’s natural gas imports. Iran also exports natural gas to Armenia and Azerbaijan, albeit with minor volumes (a total of 1 Bcm in 2012). In order to maintain these commitments and in order to satisfy its own domestic demand (particularly in winter time), Iran has to import natural gas from Turkmenistan. By importing about 9 Bcm of natural gas (data of 2012) Iran accounts for about 30 percent of all Turkmen natural gas exports.
In this overall situation, Iran basically emerged to be a net-importer of natural gas since 1997. This paradoxical situation is mainly due to a long-lasting situation of under-development of Iran’s natural gas sector. A situation generated by a series of barriers of geopolitical and commercial nature that will be widely explained in the next section.
The Political and Commercial Barriers to the Development of Iran’s Gas Market
As far as geopolitics is concerned, the key issue is surely represented by the difficult relations established between Iran and the West after the Iranian Revolution of 1979 and -more recently- after Iran refused to suspend its uranium enrichment program. Since 1979 the US imposed sanctions against Iran to influence the country’s policies and expanded them in 1995 to include firms dealing with the Iranian government. In 2006, the United Nations (UN) Security Council passed Resolution 1696 and imposed sanctions after Iran refused to suspend its uranium enrichment program, which Western governments fear is intended for developing the capability to produce nuclear weapons (Iran counters that its nuclear program is for civilian purposes, including generating electricity and medical purposes). Since 2006 the UN has adopted several rounds of sanctions against Iran, but due to Chinese and Russian opposition, however, Iran’s energy sector has not been affected by the UN sanctions. For this reason, the US and the EU have imposed unilateral sanctions targeting Iran’s energy sector. These sanctions target investments in oil, gas and petrochemicals exports of refined petroleum products, and business dealings with the Iranian Republican Guard Corps.
Notwithstanding this unfavorable international political climate, the Iranian government began to open up the oil and gas sector to foreign investment from the mid-1990s. The role of foreign players has always been controversial, however, and the arrival of a conservative government in 2005 considerably clouded prospects, notably because of its nuclear ambitions. US sanctions have effectively complicated the task of attracting investors in the past and the addition of further EU and UN sanctions since 2007 have made European and Asian companies -for a long time willing to overlook political and operational difficulties in order to gain access to Iran’s undoubted potential- unwilling to commit to investments and bid for new projects until the future direction of the international dispute becomes clearer.
With regard to the commercial barriers to the development of Iran’s natural gas sector, the key issue is surely represented by the petroleum legal framework of the country: the buy-back service contracts.
A buy-back service contract is defined as a contract between the NIOC and an international oil company (IOC), in which the IOC agrees to develop an oil or natural gas field and then to hand the field over to the NIOC once production starts. The IOC develops the field and NIOC then repays the costs, including capital expenditure (capex), operating expenditure (opex), and accrued bank charges. Additionally, the IOC receives a pre-agreed remuneration fee, normally by way of an entitlement to an amount of oil or gas from the development operation. By using a buy-back service contract framework, the NIOC has been able to meet Iran’s strict constitutional provisions restricting foreign oil companies’ involvement in Iranian oil and natural gas projects, since in the contract the IOC must hand the field back to the NIOC for production. Moreover, this policy has also enabled the NIOC to benefit from the IOCs’ technical and financial capabilities, since the IOC is responsible for developing the field.
Under the buy-back service contract system, IOCs are thus supposed to be paid in oil and natural gas from projects they develop with their own capital but then have to hand back the project to Iranian companies when completed and wait to be paid. This differs substantially from the generally used PSAs which normally allow foreign parties to own parts of the reserves and mandate share in costs and profits from development. This situation clearly represents a substantial disincentive for IOCs to get involved in Iran’s oil and gas sector. In addition to this, it has happened that the buy-back system has kept IOCs like Italy’s eni waiting for multi-million dollar payments for projects they completed decades ago, while international sanctions make it still more difficult to get the oil from Iran. For all these reasons the buy-back service contracts are generally considered as highly unattractive by IOCs, which have thus been profoundly discouraged from investing in Iran’s oil and gas sector over the last decades.
This situation concerning the petroleum legal framework currently in place in Iran, together with the international sanctions regime applied to the country over the last decades, represent the two key factors behind the under-exploitation of Iran’s natural gas sector. However, this overall situation could well change in the near future, as the country seems to be embarking into a process of reform (also involving the legal framework of oil and gas sector) and opening-up to the international community after decades of closure and hostility -notably against the US-.
Iran After the (Potential) Nuclear Deal: What's Next for the Country's Gas Market?
After 8 years of Mahmoud Ahmadinejad’s ultra-conservative politics, on June 14, 2013 the Iranian people elected the moderate Hassan Rouhani as new President of the country. With this election the Iranian people called for a deep change, concerning both the internal and external dimensions of Iranian politics. In fact, Ahmadinejad’s undiplomatic approach at home and internationally caused trouble domestically and estranged Iran abroad, resulting in social and political polarisation and economic hardship in the country. President Rouhani and the new government seemed to be willing to respond to this call for change of the Iranian people and immediately launched a series of initiatives aimed at improving the relations between the country and the West and at ameliorating the difficult economic situation of the country.
As far as the international dimension is concerned, this action primarily targeted a normalization of the relations between Iran and the West, through a diplomatic activity aimed at overcoming years of frustration and impasse in negotiations between Iran and six world powers (the five permanent members of the UN Security Council plus Germany, known as the P5+1) on the key dossier on the table: the Iranian nuclear program. A first result of this new diplomatic activity arrived in Geneva on November 24, 2013, when a first deal on the Iranian nuclear program was finally reached. This occurrence certainly represents just a first step toward a truly complete resolution of the Iranian nuclear issue, which could finally lead to a full lifting of international sanctions in 2014.
As far as the domestic dimension is concerned, this action primarily targeted a series of reforms to reinvigorate the country’s economy after years of decline. Among other things, this action has targeted the oil and gas sector, with the aim to make it more attractive for foreign investors in case international sanctions will be fully lifted in 2014. To this end, the new Oil Minister Bijan Namdar Zanganeh has proposed a reform of the country’s petroleum legal framework with the aim of phase out the current buy-back scheme in favour of new schemes that could be more attractive for foreign investors. Just ahead the OPEC meeting of December 2013, the Minister stated that the new contract model for upstream investment is being studied and it will likely be somewhere between the buy-back model and a more common production sharing agreement model. Zanganeh also stated that details of the new contract framework would be discussed at a conference that will likely take place in the second-half of 2014 in London, involving representatives of international oil companies and other experts.
In a scenario on which a final deal on the Iranian nuclear program will be actually reached, and a reform of the petroleum legal framework will be really completed, the outlook of Iran’s oil and gas sector could well dramatically change for the better.
In fact, in such a scenario IOCs will likely come back in Iran in order to re-start exploration and production activities ended after the international sanctions were imposed by the US and the EU on the country’s oil and gas sector.
At this point the question is: how will all these developments reshape the country’s natural gas market outlook?
- The short term outlook
In the short term, the hydrocarbon activities in the country will likely be focused on additional oil exploration, production and export. As Minister Zanganeh stated: «Our first priority is for enhanced oil recovery. It will be both for undeveloped and underdeveloped fields especially we prefer to start negotiations for enhanced oil recovery, for developed and existing fields.» This plan implies that in the short term even more natural gas will need to be utilized for reinjection into oil fields in order to sustain a growing oil production.
Moreover, in the short term Iran will likely make use of its natural gas resources to improve the competitiveness of its economy, through a larger share of power generation based on cheap natural gas and through further investments on compressed natural gas (CNG) vehicles, in a move to reduce the domestic consumption of oil, which could thus be freed-up for additional exports.
In this overall situation, it is thus very difficult to expect major volumes of additional natural gas exports from Iran in the short term. Most probably, a volume of 10 Bcm of natural gas per year will likely represent the only additional export volume of Iran in the short term. In fact, in March 2014 Iran signed a 25-year agreement to supply 10 Bcm of natural gas per year to Oman, starting by 2017. The deal will require the construction of a 260 km-long subsea pipeline from Iran’s Hormozgan Province to Oman’s Sohar port on the other side of the Persian Gulf.
Figure 4 - Proposed Iran-Oman natural gas export pipeline
Source: own elaboration (2014).
As part of the deal, the two countries have the option of forming a joint venture to export the natural gas. This detail is not surprising, as in the past the two countries - long-time allies - have discussed several times the opportunity of bringing Iran’s natural gas to Oman’s underutilized LNG export facility, thus establishing Oman as a new hub for future Iranian natural gas exports. The current plan would consist in keeping about 30 percent of the natural gas exported to Oman as Iranian natural gas to be processed into LNG by Oman LNG under a tolling agreement, allowing it to market, for the very first time, what would be “Iranian LNG”. This project would thus represent the first move of Iran into the global LNG markets.
- The long term outlook
In the longer term, Iran’s natural gas resources will likely be intensively exploited with the aim to export major volumes to the international markets. At this point the question is: what is Iran's natural gas export strategy likely to be? Over the last decades a number of natural gas export projects have been discussed in Iran. As Jalilvand (2013) outlined, at least 15 projects have been put on the table: a pipeline to Bahrain, a pipeline to Kuwait, a pipeline to the United Arab Emirates, a pipeline to Syria, a pipeline to Iraq, a pipeline to Pakistan and India, a pipeline to Europe and 7 different LNG projects.
Among all these projects, over the last years Iran seemed to be particularly focused on the pipeline to Pakistan (a 22 Bcm/y pipeline projected to run from Assaluyeh in Iran to Nawabshah in Southern Pakistan) also because a major share of this pipeline’s capacity is devoted to supply natural gas to Iran’s domestic market itself (only 8 Bcm/y are supposed to be exported to Pakistan). As a matter of fact, Iran has already completed most of the 1,050 km leg from Assaluyeh to its border with Pakistan. However, this project is advancing slowly as Pakistan is not fulfilling its side of the deal (Pakistan has for some time now been unable to move ahead with its segment of the pipeline due to a serious lack of funds). After having suggested that Iran would annul its natural gas export contract with Pakistan, Oil Minister Zanganeh stated in November 2013 that Iran is still prepared to supply natural gas to Pakistan if it shows signs of real progress on its side of the project. According to the resolution of this issue on the Pakistani side, the Iran-Pakistan pipeline could thus be seen as a front-runner project in the future Iranian natural gas export strategy. By the way, an added value of this project is the potential for extending the pipeline to India, a country that is set to dramatically increase its natural gas consumption and import requirements after 2030. The overall project could thus well represent a major opportunity for Iran in the long term.
Figure 5 - Proposed Iran-Pakistan-India export pipeline
Source: own elaboration (2014).
However, this project will likely advance very slowly, as Iran will first need to ramp-up its natural gas production in order to provide the base for consistent additional natural gas exports. Such a development will require the involvement of IOCs in the country, an involvement that will unlikely occur -as previously described- without a new petroleum legal framework in the country. A full resolution of the nuclear issue will thus not automatically change the Iranian gas market outlook, albeit it will certainly represent the first essential step on the way that will lead Iran to the international natural gas markets.
In the introduction of this study we referred to Iran as the perennial “elephant in the room” of international gas trade. To conclude, we can thus close the ring by saying that the “elephant” will need a bit of time to move. However, albeit in the long term, it is sure that its movement will ultimately have a profound and long-lasting impact on international gas markets.
FEEM Nota di Lavoro 31.2014