Energy superpower Iran will be a global game-changer

Iran’s return to the international arena could fundamentally change the global energy market. Regaining access to foreign investments and technology may well allow it to become an energy superpower.

But first, a number of uncertainties must be resolved. Iran is more resource-rich than Russia or Venezuela, coming N°4 on oil reserves and N°1 by far on natural gas. Three-quarters of its recoverable reserves have yet to be exploited.

Historically, Iran has also been at the forefront of energy production since it first began to extract commercial oil in 1914, and gas in 1983. But last year, despite its vast reserves, Iran produced only 3.6m barrels of oil a day and 172.6bn cubic metres of natural gas. Two major factors have been responsible for the crippling underdevelopment of Iran’s energy sector. First there were the international sanctions imposed as a response to Iran’s nuclear programme, and second there has been mismanagement. Oil and gas exports account for around half of the Iranian state’s budget revenues, and more than a fifth of its GDP. The sanctions banning supplies of Iranian energy to EU countries had a significant impact on Iran’s economy because until then Iran delivered almost a third of its 2.5m barrels of daily crude oil exports to the European market. This dropped to less than a million barrels a day in 2011-2012. Limited export possibilities caused only half of this reduction. Iran was also hit by an inability to deliver to Asian markets because of the ban on American and European insurance companies providing services for shippers of Iranian oil. By 2013, the state’s income from hydrocarbon exports fell by almost half and by 2014 reached a 25-year low.

Sanctions were the straw that broke the camel’s back for Western oil and gas companies operating in Iran, but the mismanagement of the Iranian energy industry and the unprofitable “buyback” contracts offered by the state-owned National Iranian Oil Company (NIOC) have long kept them from reaching their own targeted rates of return internally, and made them liable for all cost overruns. From 2012 onwards, only a few Russian energy companies along with China’s National Petroleum Corporation and Sinopec continued doing business in the Islamic Republic.

Capital flight from Iran also hit the country’s upstream sector severely. That translated into a lack of advanced exploration technologies and drilling equipment, resulting in serious delays for long-term projects like the hugely important LNG terminal that has now been on hold for some 30 years.

Almost all of Iran’s proven oil reserves were discovered before 1965, and more than a half of all its hydrocarbons still come from 70-year-old fields whose output is shrinking by 10% annually. Even so, substantial volumes of the natural gas that results from the crude oil extraction process are flared because the infrastructure to capture and transport it is not in place. Iran thus wastes almost as much gas as Azerbaijan produces.

With the West’s sanctions lifted, Iran should now be able to open up economically and politically so that it can benefit from its oil and gas wealth. The international sanctions are all set to be removed by mid-2016, giving Iran a real chance to boost its economy, develop its under-financed energy sector and become a true energy superpower.

Energy giants like Total, Royal Dutch Shell, Lukoil and Eni have already expressed their strong desire to return to Iran, and look set to lead the return of foreign direct investments there. They have initiated a dialogue on post-sanction opportunities. It is not only the lifting of sanctions that rekindled their interest but also – given bleak prospects for an oil price recovery – Iran’s easily-accessible and low-cost oil fields. Their willingness to take part in joint upstream projects while bringing modern technology and know-how could give the Iranian energy sector a decisive boost.

Projects ranging from exploration to the development of early life and mature oil fields along with gas fields are on offer by the Tehran government. Iran’s oil minister Bijan Namdar Zanganeh believes that within seven months of the sanctions’ full removal, Iran will have raised its present output of 3.6m barrels a day to almost 4m barrels of crude oil, and 4.7m barrels soon after that.

Less optimistic scenarios point to 4.4m barrels a day by 2025, but in the short term also see five major projects in the South Pars gas field coming on-stream, potentially increasing natural gas production capacity by around 170m cubic metres a day, which would mean a doubling of its 2014 output.

To achieve these feats, Iran will not only need the sanctions to be lifted but will also require significant foreign investment. And it is far from certain that these two pre-requisites will materialise. Iran may not completely fulfil the sanctions regime or the Iranian Parliament might foil its implementation. Iran will also need $50-100bn in foreign investments to finance these boosts to production, whereas the World Bank is estimating the FDI inflow for 2016-2017 at a bit more than $3bn.

The Iranian government will need time to overcome the years of mistrust, managerial problems and lack of capital that have dogged the country’s energy sector. To accelerate matters, Iran is now rolling out by the end of 2015 its improved system of Iranian Petroleum Contracts (IPC) in the hope that these new partnership agreements will spur investment by offering long-term perspectives and greater flexibility suited to changing conditions in the field.

If Iran is able to reach its pre-2012 level of crude oil exports, an additional one million barrels of crude oil will reach world markets daily by end 2016. The World Bank reports that such an increase could well result during the course of next year in a further reduction by $10 in the battered oil price. In a first phase, that would benefit consumers in Asia and Europe by boosting their economies, and the United States and the European Union would together see over $110bn wiped off their energy bills. Exporters like Saudi Arabia and Russia will be struggling to balance their budgets that were predicated on oil and gas revenues twice current levels. When Iran pumps more oil onto the world market, it will also potentially increase competition for Saudi Arabia.

The prospect of an Iranian gas-exports bonanza will offer major importers like Europe and Asia greater leverage vis-à-vistraditional pipeline suppliers. But while Europe’s energy security is about maintaining supply, for Iran it is about a reliable demand, especially for its gas. Developing its liquefied natural gas (LNG) exports will be essential if it is to compete with Qatar, or before with the U.S. But Europe should not count on easy access to Iranian gas, as it may instead be destined for long-term contracts with more attractive Asian markets. This would nevertheless have positive effects for Europe’s consumers as an increased gas flow towards Asia would push prices downwards there too.

For all the many unanswered questions that remain, the signs all point to Iran’s future as an energy superpower. For the Islamic Republic itself, an economic miracle looks to be well within reach. More widely, an Iran re-integrated into the international community may possibly pose challenges for some countries in its region, but more likely offers a genuine chance for peace and prosperity there.