United States Institute of Peace

The Iran Primer

The Oil and Gas Industry

Fareed Mohamedi
  • The Iranian economy is heavily dependent on the lucrative oil and gas sector. But the vagueries of the oil markets and Iran’s reliance on a single resource for most of its income has created disincentives to develop a more diversified and globally integrated economy. Consequently, the sector has been a source of periodic but persistent economic instablity.
  • Iran’s oil and gas sectors have critical structural problems. Subsidized prices and a population that has doubled sinec the 1979 revolution has created excessive demand. Supply has been stymied by underinvestment caused by financial constraints, technical shortages and sanctions. Iran is a net importer of gas and is under pressure to avoid becoming a net importer of oil.  
  • The government of President Mahmoud Ahmadinejad has asserted its control over the oil and gas sector. It has reduced the power of the “oil mafia,” dominated by allies of former President Akbar Hashemi Rafsanjani, and replaced it with companies associated with the Revolutionary Guards.
          In 1908, Iran was the first country in the Persian Gulf to discover oil. Petroleum has been the primary industry in Iran since the 1920s. Despite Tehran’s attempts to diversify the economy, the oil and gas industry is still the critical engine of economic growth. Oil revenues accounted for 65 percent of government revenues in fiscal year 2008-2009, although it comprised only around 10 percent of the gross domestic product. This trend has remained fairly steady over the last few decades.
         The Iranian government’s dependence on oil revenues has resulted in prolonged patterns of rentierism—or dependence on a single natural resource—in its political economy. Some analysts suggest that Iran’s “revenue autonomy” and access to large amounts of foreign exchange have helped fund an eight-year war with Iraq and extremist groups.
         But Iran’s oil sector has also suffered setbacks. Production was acutely affected during the revolution, especially by workers’ strikes. During the Iran-Iraq War, the invasion of oil-rich Khuzestan and the port of Abadan severely impacted revenues. And Iran’s support for militant movements led to sanctions that crippled its ability to buy badly needed equipment and new refineries from the West.
         The revolutionary government has struggled since the 1979 revolution to maintain oil production above 3.5 million barrels per day—just over one-half of production under the last shah. Iran produced 6 million barrels per day in the monarchy’s final years. Production fell to a low of 1.5 million barrels per day in 1980. The long period of low oil prices between 1986 and 2000 also crippled Iranian revenues. 
          Iran’s revenues have fluctuated due to the vagueries of the world’s oil markets, periodically depressing government revenues. The government has often not been able to cut spending for political reasons and funded its deficits by borrowing from the Central Bank. Periodic bouts of lower oil prices have also led to foreign exchange shortfalls and a fall in imports, especially industrial inputs. Excessive domestic demand and disrupted industrial production has lead to periods of high inflation.
          Misuse of oil revenues has also caused long term-economic problems. After he was first elected in 2005, Ahmadinejad embarked on a populist spending program encouraged by higher oil prices. However, his plan has overcommitted the government to support social welfare, which Tehran will not be able to afford if oil prices remain low long-term. Iran has built up its foreign exchange because of higher oil prices over the past decade. But should oil prices fall, its reserves could be depleted rapidly. Ahmadinejad has already subverted the Oil Stabilization Fund, which was originally designed to save excess oil revenues in a rainy day fund. He tapped the fund to support higher spending levels. 
          Iran’s longstanding subsidies—to support consumption of refined oil products and natural gas—have also become a huge burden on the Iranian budget and its balance of payments. Iranians pay as little as 38 cents for a gallon of subsidized gasoline. This has resulted in runaway consumption and rising imports of gasoline. Iran currently imports up to 40 percent of its refined oil needs, because its own refineries cannot handle the volume needed for domestic consumption. Gasoline imports, which have to be paid for in hard currency at world market prices, account for around 3 percent of Gross Domestic Product (GDP). This, however, does not measure the true cost of subsidies. Total petroleum subsidies, including for consumption of those domestically produced, accounted for 20 percent of GDP.
          Iran is the second largest OPEC producer and the fifth largest globally (after Russia, Saudi Arabia, the United States and China). In 2010, it produced some 3.7 million barrels per day. Its oil sector is one of the oldest in the world. Production started in 1908 at the Masjid-i-Suleiman oil field. As a result, Iran has one of the world’s most mature oil sectors. About 80 percent of its reserves were discovered before 1965. Iran has already produced 75 percent of its reserves, so the likelihood of other major discoveries is low. Iran has made some important new discoveries in the past decade, such as the Yadavaran and Azadegan fields, but they have not been sufficeint to alter the trend in oil reserves depletion.
          The National Iranian Oil Company (NIOC) has held crude production within the 3.8 million to 4.0 million barrels per day range for the last several years. This has been a major achievement since most oil sectors with depletion rates of 75 percent usually witness steep declines in production. Indeed, Iran’s base production is declining around 4 percent per year. The recently discovered new sources have allowed Iran to hold oil production relatively steady, and they may even help production levels to grow somewhat in the immediate future. But new sources will not be able to offset natural declines beyond the short-term. As a result, Iran will have to rely heavily on proven but undeveloped reserves, which will require major new investments. Production capacity is likely to fall because of geological constraints, the lack of domestic technical capacity, financial constraints and international sanctions.
           In the 1990s, Iran attempted to attract foreign companies to develop its crude oil reserves, partly because it lacked the technical and financial resources to develop them. The contract terms were called buy-back arrangements, whereby foreign oil companies developed the field and were paid back in crude oil produced. The field under development was returned to NIOC’s control after repayment was completed. These arrangements were unpopular with foreign companies, even though several large oil and gas fields were developed. The threat of renewed sanctions and Iranian refusal to provide better terms has led most private Western companies to leave.
           In the last few years, Tehran has increasingly looked East to attract national oil companies into the Iranian upstream industry. The greatest activity has been with China, which has held talks on major projects since Sinopec signed the contract for the Yadavaran field in 2007. But proceeding to actual development has been slow, even for Yadavaran. It remains to be seen whether these other projects will move forward in the near term.

Refining capacity
           Iran’s refineries are operated by the National Iranian Oil Refining and Distribution Company (NIORDC). It operates nine refineries with a combined refining capacity of 1.775 million barrels per day. Capacity has almost doubled since the early 1990s and considerable work has been done on upgrading the refineries. 
           But a significant portion of what Iran’s refines is low-value fuel oil. It still relies on imports of higher value-added refined products, such as gasoline, jet fuel and diesel, to accommodate the growing public appetite for subsidized fuels, especially gasoline and gas oil. In early 2006, NIORDC announced plans for a $16 billion program to expand and upgrade its refineries, with a goal of doubling its capacity to around 3.3 million barrels per day. As of mid-2010, several projects were underway, but the bulk of the program will not be completed in the next several years because of Iran’s financial constraints and international sanctions.
Natural gas
           Iran has the second largest gas reserves in the world after the Russian Federation. For two decades, its production growth has increased by an average of 10 percent, yet Iran has only depleted 5 percent of its gas reserves. Iran’s problem is that its ability to produce has lagged behind its domestic needs. Demand has surged because of economic and population growth. Natural gas has also been liquified and used as a substitute for gasoline and other transport fuels. As its oil sector has become more mature, the government has had to use more gas for reinjection into maturing oil fields in order to maintain oil production. 
           Iran must continue to develop its reserves at a rapid rate to meet this demand.  Iran’s main asset is the giant off-shore South Pars field in the Persian Gulf, which it shares with Qatar. It is the world’s largest gas field. Qatar has sped ahead with development of its field, but Iran has lagged way behind. Tehran has made some progress in developing several phases of the South Pars gas field in recent years. But achieving full potential of this giant field plus other fields will be a challenge over the near term because of technical and financial constraints.
           Developing its natural gas sector also requires a heavy commitment to building the necessary infrastructure. Iran’s gas production is in the south of the country, but the bulk of its demand is in the north. It has built an impressive pipeline network to transport this gas, but again growing demand has increased the need to expand domestic pipelines.
          Since it can barely meet domestic demand, Iran will not be able to deliver on its ambitious gas export program beyond the current pipeline exports to Turkey. By 2010, none of the plans to export to Oman, the United Arab Emirates, India, Pakistan, Europe (all by pipeline) and China (by liquified natural gas) had even started. For its own needs, Iran will continue to rely on gas imports, mainly from Turkmenistan. These are getting more expensive, however, because of competition for this gas from China.
Industry structure and control
          The Ministry of Petroleum, which has control over the National Iranian Oil Company, reports to the president with oversight from the parliament. But the dividing line between the ministry and Iran’s oil company is often indistinct. The position of NIOC managing director was only established in 2000 as a separate post. But in reality, as a vestige of the past, the two institutions still share personnel and offices. 
          The Ministry also controls the National Iranian Gas Company, the National Iranian Petrochemical Company, and the National Iranian Oil Refining and Distribution Company. In 2006, the ministry submitted a bill to parliament proposing that NIOC manage all four companies. But the bill did not pass because Ahmadinejad’s supporters did not want the ministry to create more autonomous companies.
          For most of the revolution’s first three decades, an “oil mafia” under the influence of former President Akbar Hashemi Rafsanjani controlled both the ministry of petroleum and the National Iranian Oil Company. Ahmadinejad initially failed to assume control over the sector after his election in 2005. Parliament rejected his first few choices for oil minister. In his second term, he was become more successful in prying control away from the oil mafia, especially after parliament approved Massoud Mir-Kazemi. In a reflection of the power shift, Mir-Kazemi has a strong background in the Revolutionary Guards and the defense ministry. He was former head of the IRGC think tank, the Center for Fundamental Studies. 
          Under Ahmadinejad, the Revolutionary Guards’ influence has grown within NIOC, as well as in the service sector. Khatam ul-Anbia, the IRGC construction arm, has strengthened its role throughout the Iranian economy, including the oil and gas sector. In 2006, it won a contract to develop South Pars Phases 15-16. In 2009, it took over the Sadra Yard, a firm that has built many platforms in the Persian Gulf and the recently completed Alborz semi-submersible rig which will drill in the Caspian Sea. While the Revolutionary Guards’ profile is growing, it also faces financing difficulties. International sanctions have deterred banks from funding Phases 15-16 due to its link with Khatam ul-Anbia.
The future
  • International sanctions will slow investment in the oil and gas sector in the next few years, which could lead to a decline in output.
  • A sharply lower oil price would destabilize the Iranian economy, since Iran balances its external accounts around $75 per barrel.
  • Falling oil and gas output and lower oil prices will weaken the government’s ability to stimulate the economy, which could result in slower economic growth and higher unemployment.
Fareed Mohamedi is partner and head of oil markets and country strategies at PFC Energy, a Washington DC based oil and gas consultancy.
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