Industry Spotlight: Oil and Gas (2019)

By Andrew Lumsden, Research Fellow

When AIC last reported on Iran’s oil and gas sector in February 2018, there was a great deal of optimism surrounding its future among Iranian officials and many international investors. The sector had been boosted by the 2015 Joint Comprehensive Plan of Action (JCPOA), which relieved some U.S., UN and EU restrictions on Iran’s access to foreign investment and export markets.

Much however, has changed since May 2018, when the Trump Administration announced its intention to withdraw from the JCPOA. Despite the country being home to the world’s fourth largest reserves of crude oil and second largest reserves of natural gas, the future health of Iran’s fossil fuels sector is now shrouded in uncertainty.  

Crude Oil

Exports

Iran’s economy is heavily dependent on the export of oil. Some 40% of the funds in the government’s current annual budget come from that trade. Iran’s ability to export its oil however, suffered a severe and immediate blow when the U.S. announced its intention to restore sanctions.

Most of Tehran’s buyers quickly began scaling back their purchases of Iranian oil and the country’s overall oil exports saw a net decrease of one third between May and October 2018.

Iranian oil exports rebounded slightly after the Trump Administration offered “Significant Reduction Exceptions” (SREs) to eight of Iran’s oil importers in November 2018. With the SREs, China, India, Italy, Greece, Japan, South Korea, Taiwan, and Turkey would be allowed to buy Iranian oil without penalties for 180 days so long as they reduce their purchases.

Greece, Italy and Taiwan declined to resume purchases of Iranian oil, while Japan, South Korea, Turkey, China and India resumed or continued buying at reduced quantities. Nevertheless, in spite of the SREs, Iran’s total exports still fell by another 300,000 barrels per day (bpd) between November 2018 and March 2019.

On April 22, 2019, the Trump Administration announced that it will seek to drive Iran’s oil exports as close to zero as possible, and that no additional SREs would be granted. Furthermore,  existing ones would not be renewed after the expiration on May 2nd. Any country now caught buying Iranian oil could themselves face sanctions from the United States.

India, as well as China’s state-run oil companies Sinopec and CNPC have all since ceased importing Iranian oil. Bloomberg reported that so far in May 2019, no ship has been recorded leaving Iran’s oil terminals. While this may suggest that Iran’s oil export economy is in a catastrophic state, the report notes that oil tankers can easily conceal their movements by turning off their signaling devices and that Iranian vessels are known to have done so in the past.

Production

With the country’s export markets drying up, crude oil production in Iran has accordingly declined. A slight increase between December 2018 and January 2019 notwithstanding, Iran’s production of crude oil has been declining precipitously, from 3.8 million bpd in June 2018, to 2.7 million bpd in March 2019. A production rate unseen since before the 2015 nuclear deal. Iranian monthly oil production is actually declining at a faster rate today than in the months following the initial imposition of U.S., EU and UN sanctions back in 2011.

Furthermore, if U.S. sanctions continue to block foreign investment, steeper declines in Iranian oil production are to be expected in the coming years. In 2017, Iranian oil officials warned that some 80% of the country’s active oil fields are nearing total exhaustion, and that significant financial and technological investment would be required for the development of new fields and effective management of active ones. Since the U.S. announced sanctions in 2018, most foreign investors have cancelled or indefinitely suspended their planned projects in Iran.

Natural Gas

Iran’s natural gas sector has fared significantly better than its crude oil counterpart in the post-JCPOA era. More than two-thirds of Iran’s natural gas is consumed domestically, and the little that is exported goes to neighboring Turkey, Armenia, Azerbaijan, and Iraq. These states have largely resisted U.S. pressure to cut back imports of Iranian gas, having found no commercially viable alternative source. In fact, Iraq, over U.S. protests has vowed to increase its imports of Iranian gas by 7 million cubic meters per day (mcm/d) by June 2019.

Iran’s gas production has also held firm. Although Iran’s Oil Minister has claimed much higher rates, independent analysts put Iran’s 2018 natural gas production at a rate of 635 mcm/d.  According to British Petroleum’s data, this represents a 20mcm/d increase over the previous year. Furthermore, if the new sections of the South Pars Gas Fields in the Persian Gulf, which Iran has continued to develop despite the flight of foreign investors, come online at the end of 2019 as planned, Iran could increase gas production by an additional 56 mcm/d.

Iranian Response

Iranian leaders have maintained a defiant approach to U.S. sanctions, however their options for countering U.S. sanctions may be limited. President Hassan Rouhani vowed that the country will flout the U.S. and actively search for willing oil importers, and Deputy Oil Minister Amir Hossein Zamaninia said that Iran would sell oil on the “gray market.” Analysts suggest this may mean clandestinely selling oil through private firms.

Although no country has of yet declared an intention to openly defy U.S. sanctions on Iranian oil imports, there may be good reason for Tehran to be optimistic about finding willing oil buyers. Between the 15th and 17th of May 2019, at least two oil tankers, the Marshall Z and the Pacific Bravo, have reportedly been tracked loading sizable quantities of crude oil and fuel oil in Iran and proceeding to ports in China. If true, these reports may suggest that China may ultimately be willing to defy U.S. sanctions.

Nevertheless, flouting U.S. sanctions may still be easier said than done for Tehran. Firstly, it should be noted that China is itself in an escalating trade conflict with the United States, which may be the reason it appears willing to flout U.S. sanctions. Furthermore, only about 24% of Iran’s annual oil exports go to China. Tehran’s other key buyers such as, India, South Korea, Japan and EU members, largely have good relations with the U.S. and are far less likely to defy Washington’s sanctions.

Secondly, other oil producing states, including  Saudi Arabia and Russia have already been working to replace Tehran by increasing their oil production and pursuing Iran’s former business partners. Many of these, including China, may ultimately choose to turn to these states to meet their oil needs, as opposed to risking economic conflict the U.S. by buying from Iran.

Rouhani also called for Iran to boost its non-oil exports as a means of countering U.S. sanctions.

However, this may prove difficult as well. Due to sanctions, Iran’s non-oil exports declined 1.3% between March 2018 and March 2019 over the previous fiscal year, and are expected to plummet further as more trading partners shy away from doing business with Tehran.

Perhaps Iran’s best chance for avoiding sanctions would be to await the outcome of the 2020 U.S. presidential election. Nearly all Democratic Party candidates have vowed to re-enter the JCPOA if elected. However, Iran’s decision to partially withdraw from the JCPOA on May 8, 2019 and its threats to resume uranium enrichment within 60 days, may make rejoining the deal and relieving sanctions difficult even for willing Western leaders.  

Future Outlook

The World Bank projects that if U.S. sanctions remain in effect, their damage to Iran’s oil export sector will cause the country’s economy to contract by more than 5% by 2021. Moreover, annual inflation rates are expected to reach nearly 40% by 2020, government deficits are expected to expand, as will poverty rates.