Iran: miracle or mirage?

After a nuclear deal was struck between Iran and the West in Vienna last year, many anticipated it would be the first step in Iran’s transition toward becoming a global oil and gas superpower. On face value, dropping Iranian sanctions seems like a game-changer for regional and global gas markets - Iran has huge potential as a supplier given its large, cheap reserves, and a strategic location amidst energy hungry neighbours.

In reality, however, this narrative only partially holds water. While Iranian oil has already begun to hit European markets – a product of years of stock accumulation under sanctions and higher utilisation of existing capacity – any vision of Iranian gas flooding into Europe at similar levels in the near future is likely a mirage.

According to recent analysis from Aurora Energy Research, three key elements will restrict Iranian gas exports, particularly to Europe:

A growing domestic market

Despite Iran’s natural potential as a gas supplier, sanctions have strongly favoured domestic consumption, to the point that Iranian gas demand per capita is among the highest in the world. This leaves little room for export, and Iranian demand will keep on rising, driven by rapid post-sanction GDP growth and a highly gas-intensive oil extraction industry. If Iran wants to expand production beyond its burgeoning domestic demand, it will take several years to develop the new and necessary infrastructure.

Unfavourable pipeline economics for European exports

In the short to medium term, infrastructure capacity limits Iran’s ability to sell gas beyond Turkey, which itself has growing demand. Even in the long run, extra transit infrastructure that could take Iranian gas through Turkey to Europe would serve little purpose and is unlikely to be built. With Russia able to pivot its exports from Turkey to Europe, Iranian gas will be absorbed by Turkish demand before reaching the European border. If anything, a more likely destination for Iranian gas exports will be Asia, where demand is set to rise rapidly.

A marginal position on the LNG supply curve

Iran is unlikely to develop LNG over the next decade: in an oversupplied market any new projects in Iran would be uncompetitive with existing infrastructure running only on variable costs. As the LNG market rebalances in the mid-2020s, there could be an opportunity for Iranian trains to meet increasing demand, but they would still face fierce competition from more established players with similar long run marginal costs, like the US and Qatar. Realistically, given Iran’s current lack of established LNG capacity, its more pressing need to invest in already existing gas infrastructure, and perceived geo-political risks, the country will only seize a limited share of new terminal build-out.

With the limitations laid out above, Iran will most likely only become a middle-player in long-term regional pipeline and global LNG markets, not the superpower its resources suggest. The majority of its pipeline exports will be channelled to Asia and Turkey in the next two decades, and any potential for LNG will only come to fruition in the mid 2020’s.

Of course, policies and political events can lead to deviations away from this scenario, particularly if Iran were to cut subsidies to stifle domestic demand. Outside the domestic market, significant changes in supply and demand fundamentals could also impact Iran’s gas sector. If Asia were to enact ambitious policies favouring coal-to-gas switching, it would drive increased global LNG activity and create earlier incentives for the development of Iranian liquefaction capacities. The upside possibilities for European demand are far smaller, however, and are unlikely to affect markets as distant as Iran.