Recent OPEC decision indicates that a year after the Iranian nuclear deal, Tehran still lacks the capacity to increase its oil output and challenge major industry players, including Russia.
Iran's Oil Minister Bijan Namdar Zanganeh, center right, attends the opening session of the 15th International Energy Forum Ministerial meeting in Algiers, Algeria, Tuesday, Sept. 27, 2016. Photo: AP
On Sept. 28 the OPEC countries managed to reach an agreement on modest oil output cuts after two and a half years of unsuccessful talks. The OPEC oil cartel announced it would decrease oil production to 32.5 million barrels a day from the current output of 33.24 million (a reduction of about 740,000 barrels a day). The deal is supposed to take an effect in November of this year.
In 2014, when global oil prices plunged, major oil producing countries – including Russia and OPEC member states – found themselves in a dire situation where their budgets started to experience a lack of cash flow coming from oil exports. That budgetary strain pushed them towards attempts to negotiate a freeze of oil production to push oil prices up, thereby easing their burden.
The nuclear deal with Iran, which was struck in July 2015, added to the fears that Iran after sanctions relief would increase its oil output, further adding to the downward pressure on the oil price. In fact, Iran was seen as one of the major obstacle for the deal to be struck as Tehran did not want to freeze its oil production while it was trying to restore its oil output to pre-sanctions levels. However, now it seems that everyone in the oil cartel has finally agreed to limit oil production, which might also indicate that Iran is not able to increase its oil output any further and also needs higher oil prices.
A little over a year has passed since the nuclear deal with Iran, also known as the Joint Comprehensive Plan of Action (JCPOA), was signed which offered Iran relief from economic and financial sanctions and resulted in speculation about how Iran would quickly increase its oil output, affecting the global oil market and threatening Russia’s energy interests in Europe.
EU and UN nuclear-related economic and financial sanctions imposed on Iran have now been terminated (most of them were lifted in January 2016). U.S. legislation imposing nuclear-related economic sanctions have also been suspended. This initial phase of sanctions relief affects the major sectors of the Iranian economy, including the oil, gas and petrochemicals industry.
However, 14 months after the nuclear deal was reached and eight months after most of the Western economic and financial sanctions have been lifted, Iran still lags behind its planned economic revitalization goals and renovation of its energy sector. Contrary to what many analysts warned about, Tehran has failed to significantly increase its oil output and challenge major industry players including Russia. In short, Iran’s attempts to regain market share in the oil industry have underperformed expectations over the past year.
Expectations vs. reality
The Iranian economy and oil industry were hit by economic and financial sanctions imposed in 2011-2012 the hardest. The oil embargo, which was introduced at the same time, also added to the effect. Starting from 2012, the Iranian oil industry’s output dropped by 17 percent, from 3.74 million barrels a day (mbd) in 2012 to 3.12 mbd in 2014, while its oil exports decreased by about 60 percent from a peak of 2.5 mbd before 2012 to just over one million in 2013-2015.
The oil embargo consequently decreased Iran’s oil exports to Europe in 2012 by 80 percent, from 0.78 million barrels in 2011 to 0.16 million barrels in 2012. In 2015, Iran exported only 0.1 million barrels of crude oil to Europe, which is just 14 percent of 2011 volumes. This led to the loss of Iranian share of the oil market, which was quickly taken over by Libyan and Nigerian oil.
While bargaining with the P5+1 powers (the permanent members of the UN Security Council, plus Germany) over the nuclear deal, Iranian officials repeatedly stated that once the deal was struck and major Western sanctions together with the oil embargo were cancelled, it might increase its oil production by one million barrels a day within six months. However, the reality turned out to be different.
In January 2016, when the West agreed to lift a major part of the nuclear-related sanctions, including the oil embargo, pundits expected that Iran would quickly restore its oil production and even exceed its pre-sanctions level output, which would cause global oil prices to fall further during the year. However, such expectations proved to be too alarmist as eight months after the lifting of sanctions, Iran is still struggling to reach its pre-sanctions level.
According to the OPEC Annual Statistical Bulletin 2016 and its September Oil Market Report Iran managed to increase its oil output by 480,000 barrels a day (15 percent increase) in eight months from 3.15 mbd in 2015 to 3.63 mbd in August 2016. Thus, Tehran fell short of reaching its pre-sanctions oil production level of 3.7 mbd and failed to hit the 4 mbd target as its leadership promised.
Iranian oil threat to Russia
Russia, as the EU’s main oil exporter for years, is unlikely to be challenged by Iran. For years Russia has been consistently supplying about 30 percent of the EU’s crude oil imports. Iran’s oil exports to Europe dropped by 86 percent by 2016. Ever since sanctions were imposed in 2011-2012, other oil suppliers have taken Iran’s European oil market share, which makes it quite challenging for Tehran to regain its market share.
According to the Iranian Petroleum Minister Bijan Zangeneh, Iran's crude exports should have reached 2 million barrels a day by May 2016. As experts note, this turned out to be true and Tehran managed to double its oil shipments once the sanctions were lifted in January 2016. Moreover, its exports to Europe reached 445,000 barrels a day in May 2016. However, it is still half of what Iran used to export to Europe before 2011.
Moreover, in the first half of 2016, Russia’s crude exports are on track to set a new record as they rose 4.9 percent during the first six months of the year, which also intensifies competition on global oil markets. Finally, neither the global oil price, nor global demand for oil, is opening up a lot of opportunities for exporters.
Viktor Katona, an expert at the Russian International Affairs Council (RIAC), argues, “The competition between Iran and Russia did certainly take place, but it is far from being a full-scale scrap. Iran reclaimed mostly its traditional European markets – primarily Italy and Greece – whilst elsewhere its return was less palpable, leaving Russia more space.”
It is important to remember that Europe has never been Iran’s major oil buyer while Asia was the top market for Iranian oil. Asian economies (i.e. India, China, Japan, South Korea, etc.) are growing at a faster pace than the European economies, a fact that makes Asia more attractive to both Iran and Russia.
Nikolay Kozhanov, a professor at the European University in St. Petersburg specializing on Iran, argues that there is no global threat to Russia’s oil interests in Europe coming from Iran. “Neither the volume of Tehran’s oil shipments to Europe, nor its primary after-sanctions focus, which continues to be concentrated on Asian markets, gives a solid reason for Russia to be worried about that.”
Obstacles still facing Iran
To increase its oil output significantly, Iran needs huge investments. Its already outdated oil infrastructure and equipment cannot provide the country with consistently growing oil production. For that, Tehran badly needs large foreign investments.
Oil industry experts assess that Iran needs to secure massive foreign investments to reach that level of oil production. As RIAC expert Viktor Katona confirms, Iran should acquire additional $50-$60 billion to fulfill its plan and reach the 4 mbd threshold. According to him, within the framework of the Iran Petroleum Contract (IPC), Tehran intends to start bidding this autumn, most likely in November, to secure investment in greenfield and brownfield oil and gas projects across the country. “The Iranian government is offering production-sharing agreements to almost 30 fields. Thus, Iran’s output growth in the mid-term will in many ways depend on the success of its IPC auctioning.”
Another important obstacle is that not all sanctions have been lifted from Iran. A key role here belongs to the U.S., whose primary sanctions against Tehran, including the U.S. trade embargo, remain in force. This will in particular restrict U.S. entities from engaging in bilateral trade with Iran, thus, limiting Iran’s access to dollars.
“U.S. unilateral sanctions that remain in place are a big hindrance for Iran. Any deal serviced in dollars goes through corresponding controlling agencies of the U.S. and can be suspended," explains Russia's Deputy Foreign Minister Sergei Ryabkov.
Despite the removal of most international sanctions against Iran, European and Asian businesses continue to be restrained in reviving their cooperation with Iran. It results in fewer deals than one would expect to see.
Katona argues that a lot will depend on the U.S. 2016 presidential elections and the Iranian elections in May 2017. “If both elections witness a win on the part of a candidate inclined to reach a compromise, the situation might get better.”
The factor of internal politics in the U.S. and Iran will definitely play a specific role. Kozhanov confirms that, “Any significant change in the U.S. position on this issue should not be expected before spring-summer 2017 at the earliest.” He explains that, “Washington clearly understands that it should not restore Iran’s access to U.S. dollars fully as it is one of the only effective tools it has on Iran today.” This is why the U.S. does not give Iran full access to the external financial markets as it restrains Teheran from the funds necessary to update its aging oil infrastructure.
Another important factor is growing demand for oil in Asian markets. Traditionally, Iran’s major oil buyers were in Asia and Tehran will continue to boost its exports into the Asian economies. For now, it appears that Iran’s primary focus will be Asia, not Europe, and that alleviates any threat to Russia.