Can Iran Deliver on its Unrealised LNG Potential?
Theory & Practice
Iran holds an unusual position in the global gas industry. In theory, the argument for it as a major LNG producer seems robust. Like its close neighbour Qatar, it owns a considerable share of what is to date the world’s largest discovered deposit of natural gas, the South Pars Gas field. With approximately 226,905 million cubic meters of annual production, it is at present the world’s third largest gas producer, behind only Russia and the USA. It also benefits from strategic placement at the heart of the Eurasian landmass, with easy access by sea to the emerging natural gas markets of Asia, as well as to the major consuming nations in Europe.
Nevertheless, Iran’s export potential is woefully underdeveloped. Where Qatar is the world’s largest exporter of LNG, Iran – which possesses all the same geographical advantages – finds itself with only one on-stream LNG project, still currently in a “testing stage". What export capacity it does manage is delivered via pipeline to its direct neighbours, Turkey and Iraq, and is in any case offset by the excess gas it is forced to import from Turkmenistan to meet its own domestic requirements.
The most obvious explanation for the country’s underperformance as an LNG producer is the constraints that Western sanctions have placed on its ability to fund capital intensive projects. Consequentially, it was natural that the lifting of UN sanctions on the country in January 2016 would lead to renewed attention on Iran’s potential role as an exporter. The country’s Deputy Oil Minister, Amir Hossein Zamaninia, went so far as to predict that the volume of natural gas available for export by 2021 would rise to 365 mcm a day - putting it ahead of Quatar. Bluster from the Trump administration about reinstating sanctions has done little to dampen Iranian optimism, with speculation over the past year spurred on by two developments in particular.
Caribbean FLNG & Partnership with Total
One of these is the uncertain fate of Caribbean FLNG, an as yet unused floating liquefaction facility previously earmarked for deployment off the coast of Colombia. After a deal fell through in 2016 between the facility’s owners, Exmar Energy, and the Canadian company Pacific Exploration and Production (since renamed Frontera Energy), Iranian press outlets reported that the National Iranian Oil Company had stepped in to charter Caribbean FLNG for use on the South Pars gas field. Though the facility’s production capacity is relatively small, there are hopes that beginning to export LNG - even on a small scale - will give Iran the opportunity to build trading ties in Europe and Asia, and pave the way for future growth.
The other circumstance of note is French supermajor Total’s commitment, alongside China’s CNPC, to develop the South Pars gas field. Total’s investment over the course of the 20-year deal is expected to amount to as much as 5 billion USD; and the company has also expressed interest in helping to increase production at Iran’s only extent LNG plant, situated at Tombak Port.
However, the history of Iranian natural gas exports is an unfortunate one, littered with a wreckage of failed partnerships and misplaced ambitions. Already there are some indications of tension between Iran and their French partners, with the Minister of Petroleum, Bijan Zangeneh, having warned earlier this year that Iran reserves the option to cancel the contract without payment of damages if the company fails to invest at least 500 million USD into the South Pars 11 project by mid-2019. Zageneh also cast doubt on the involvement of Total with the Tombak LNG facility, announcing that a memorandum of understanding has instead been signed with Gazprom to study the project.
The Best Laid Plans
Such incidents follow a pattern that will have become all too familiar to observers of the Iranian energy sector. As recently as February, news emerged of the termination of plans for India’s OVL to build a $5 billion LNG export facility in Iran. This happened after Iranian authorities insisted that India purchase the LNG produced by the facility at a rate roughly equivalent to that reached in a long-term deal with Qatar in 2015; almost triple OVL’s assessment of the current market value. OVL will instead focus on upstream development of the Farzad-B gas field, leaving distribution and marketing of the produced gas to Iran.
Before this, in 2010, three LNG projects in Iran were cancelled simultaneously due to stiffening sanctions. These once again involved Total – who had previously been forced to withdraw from Iran in 2006 – as well as Shell, Repsol, OMV and CNOOC. With the end of sanctions in 2016, new investors could be forgiven for supposing that such upsets were behind them. But there are deeper structural reasons to be wary of Iran’s ability to deliver on its potential as an exporter.
Factionalism, Domestic Consumption, and the Dominance of Oil
Warning signs were already apparent in 2013, when Dr Ramin Jalilvand authored a report for the Oxford Institute of Energy studies assessing Iran’s export potential. Although recognising that sanctions had doubtless been a hindrance to the development of the country’s gas industry, Dr Jalilvand argued that their impact was not sufficient to explain the disparity between Iran’s potential export capacity and its then status as a net importer.
The report identifies three key reasons for Iran’s lack of presence in global gas markets. The first of these is its factional political system, with a mish-mash of religious supervisory-bodies, republican state institutions, and independently motivated quasi-governmental foundations each vying for control over energy projects and revenue streams. The effect of this factionalism has been to deprive Iran of long term vision, favouring projects able to satisfy short term factional goals.
The second is Iran’s massive domestic consumption of natural gas. At 19.37 billion cubic feet per day in 2016, Iran’s domestic consumption is only slightly behind China’s – a country with seventeen times its population. High consumption was exacerbated by the system of state subsidies established after the 1979 revolution, which amounted to as much as 22.6% of Iran’s GDP before reforms were instituted in 2010. Though the situation is improving post-reform, years of subsidisation have left Iran with a legacy of energy sector inefficiency, as there was little incentive to reduce the prevalence of flaring, venting and other wasteful practices while prices were kept artificially low.
The third reason is Iran’s habitual reliance on oil as its export commodity of choice, for which there are ample reasons. With a comfortable share in the global export market for oil, favouring production of the heavier fuel provides Iran with a reliable stream of foreign currency from established buyers in China, Japan and the EU. It also eliminates the risk of sizeable upfront investment in projects that may take years to turn a profit.
One consequence of Iran’s reliance on oil has been to encourage the practice of oilfield re-injection, in which natural gas is forced into depleting reservoirs to increase pressure and maintain production volumes. According to Reuters, some estimates indicate that 83 billion cubic meters of natural gas per year will be needed for re-injection in Iranian oilfields only a decade from now.
Time for a Rethink?
Be this as it may, there are good reasons to believe that Iran may be due a rethink. Depending on which analyst you consult, oil’s long term prospects are anything from mediocre to outright worrisome – at least from the perspective of a state overly reliant on oil for its income. LNG, on the other hand, is widely expected to grow strongly even as the demand for other fossil fuels slows. The Wall Street Journal recently reported growth predictions for the LNG industry through to 2040 in the order of 4-5% per year.
Moreover, as abortive efforts at pipeline projects in Turkey, Azerbaijan and Pakistan have shown, Iran won’t be able to rely on its neighbours for safe passage to the gas markets of Europe and Asia. A 2008 memorandum of understanding between Iran and Turkey, for instance, included the proposal for a pipeline from the South Pars gas field through to Europe. The plan fell through, however, because Turkish officials were unhappy to see their country used as a conduit. The gas ought to be sold to them, they argued, to negotiate their own prices with European buyers.
Embracing LNG in Iran will be expensive and technically challenging. It will force the country to reassess its long dependence on oil, and wean itself away from a revenue stream that has so far proven reliable. It will involve hard choices about efficiencies and domestic power generation. And it will require the nation to tolerate partnerships with foreign investors on terms it may not at first find favourable. But, in the long run, it would be foolish for Iran not to make that gamble.
