Middle East Economic Survey
VOL. XLIX
No 5
29-Jan
IRAN
Iran’s New Energy Picture
By Jahangir Amuzegar
The following article for MEES was written by Jahangir Amuzegar, a distinguished economist and former member of the IMF Executive Board.
Iran’s nuclear ambitions and activities, until now regarded as circumspect and suspicious, if not illegal and forbidden, have recently been given a new twist, and found support as a sanguine necessity. The case against the Islamic Republic’s nuclear program – culminating in the UN Security Council sanction Resolution 1737 of December 2006 – has been based on three allegations: (a) Iran’s years-long concealment of its clandestine nuclear activities from the International Atomic Energy Agency; (b) the disregard of a previous Council demand to halt its fuel cycle uranium enrichment; and (c) an implicit assertion that a nation endowed with the world’s third-largest proven oil and second-largest natural gas reserves could hardly need nuclear power. Taking issue with Washington’s persistent claim that Iran’s nuclear program is geared towards nuclear weapons development, some energy analysts now seem to support Tehran’s claim that its program is for electric power generation. Arguing that Iran’s depleting oil reservoirs, the government’s long neglect of proper well maintenance, growing domestic demand for fuel products, inadequacy of domestic investment, and lack of access to foreign credit and technology have resulted in a petroleum crisis under which oil exports – as the lifeblood of the Iranian economy – are likely to vanish in less than a decade. Such a prospect, it is suggested makes the country’s need for nuclear power “genuine,” and Tehran’s defense of its current program as a peaceful energy pursuit is not a “weapons deception.”1
Setting aside as separate issues the legality, propriety, necessity, or urgency of an indigenous nuclear power program for the Islamic Republic as separate issues in their own place, this review attempts to argue that (a) the reports of steep reservoir erosion and Iran’s inability to produce its OPEC quota are highly exaggerated, if not fundamentally flawed; (b) even if the alleged decline of crude oil exports in the coming years were to be true, the reasons would have to be sought in wrong policies rather than in deficient geology; and (c) assuming the fall in both oil production and exports to be the case, the gloomy prospects could still hardly provide a full justification for nuclear energy development as an economically viable alternative – given Iran’s overall energy endowments.
Predicting A Non-Event
Warning about imminent exhaustion of mineral resources is and old story, and a hallmark of ardent geologists and economic geographers. As economists have endlessly pointed out, people will never wake up one morning to find out that a particular natural resource is suddenly exhausted. Before that day comes, a lot will happen to prevent it. Examples abound. Oil reserves in the US were thought to be near exhaustion only a few years after the first oil field was discovered in Pennsylvania more than a century ago. Similar gloomy predictions have been repeated every few years ever since. The London Economist, in a special supplement in February 2003, held that “Iran will become a net importer of oil within a decade” at the very time that the country’s estimated proven petroleum reserves had been revised upward from about 90bn barrels to 130bn.
For these reasons, ominous prognosis about Iran’s future oil output may not stand the test of time. The deep-rooted and self-inflicted problems of Iran’s energy sector are neither new, nor ominous, and not unknown to government authorities. The country has failed to properly maintain its oil fields since the revolution, and particularly after severe damages sustained during the Iran/Iraq war. As a result, the recovery factor in Iran’s oil fields has declined to a range considerably below that of international norms. Yet while some oil deposits might have been permanently lost as a result of poor maintenance, oil wells’ capacity has not been irretrievably damaged and the ongoing gas injection program has significantly raised recovery factor. Accordingly, official data show that since the end of the Iran/Iraq war in 1989, Iran has actually added more oil to its reserves than it has taken out of the ground. Due also to some 1mn b/d condensates from South Pars gas fields added to the daily output, MEES estimates show an actual rise in Iran’s domestic production in recent years. In short, based on official, and generally accepted, reserves figures, at the current rate of extraction, Iran will be able to produce and export oil for the next 70 years.
Furthermore, data on annual reservoir declines, estimated at 200,000 b/d only three years ago, but raised recently by the new oil minister to 500,000 b/d now (or 13%), should be treated with a large grain of salt as such independently unverifiable figures may represent one of the oldest tricks in bureaucracy’s book. Since the Iranian government has always treated the oil ministry as a cash cow, denied it sufficient new investment funds, and appropriated oil export proceeds to various other popular projects, such scare tactics by ministry officials may simply be a clever way of forcing the budget office and the Majlis deputies to raise their annual budget share. Still further, failure to meet OPEC production quotas – in addition to being offset by over-the-quota outputs in certain other months – may not indicate physical inability to produce oil, but be part of a deliberate hawkish position within the Organization to raise prices in the market. Finally, a pessimistic outlook regarding Iran’s future oil production ignores not only new explorations under way, but also the fields already discovered and scheduled to come on-stream.
Right Focus on Wrong Problems
Iran’s enormous energy problems, serious and critical as they are, have little to do with technical or geological factors. They stem mainly from prolong Washington’s sanctions, the Islamic Republic’s ideological bent and populist policies, and the country’s increased isolation from the Western diplomatic community in recent years. These elements have been mainly responsible for both ever-growing demand for, and slowly rising supply of, major energy products. On the demand side, by paying the highest energy subsidies among the 22 countries in the Middle East and North Africa, the government has artificially raised consumers’ demand for various energy products much beyond international norms. With gasoline and other fuel prices sold at a fraction of their world averages, total yearly energy subsidies in Iran, according to a major newspaper report based on the oil ministry’s figures, range between $30bn and $42bn a year, or 16-23% of GDP, depending on fob prices in Iran’s southern ports, or the prevailing consumer prices in Europe. As a result, the appetite for the highly subsidized fuel products has arguably become the world’s highest – with annual consumption of electric power, natural gas, and gasoline growing by 7%, 9%, and 12% respectively – while population is growing by about 1.55% a year, and real per capita income by less than 4%. With most fuel prices at about one-tenth of those in the neighboring countries, an estimated $1bn worth of energy products is annually smuggled out of the country.
Furthermore, Iran’s energy use has been highly inefficient, with the so-called energy intensity at 0.3 tons of oil equivalent per $1,000 of GDP, at least 30% higher than the OECD countries’ average norm. Iran also presents a most wasteful power, transportation, and residential heating infrastructures. Power transmission and distribution system losses reportedly equal 17% of total supply. Tens of thousands of 30-year-old gas-guzzling cars roam the streets of urban centers day and night, using 34 cents/gallon gasoline. By a Deutsche Bank estimate, Iran’s 7mn cars using some 420,000 b/d of gasoline consume about the same amount as Britain’s 35mn vehicles. And not only are poorly insulated houses in the cities heated with below-cost delivered gas, but open-window mud dwellings in remote villages with no thermostats or meters are warmed by dirt-cheap fuel. According to the current minister of oil, natural gas is supplied to state owned industries “almost free of charge.” Recommendations by energy economists, and a mandate in the current Five-Year Development plan to raise energy prices to near international levels within a five-year period have so far been resisted by the Majlis and the government for fear of several social and political repercussions. Prominent among these concerns, apart from ensuing virulent inflation, has been consequent inability of the two state-owned auto manufacturers to sell “1mn cars” a year – and lay off their workers – if the price of gasoline is raised.
Lack Of Oilfield Technology
On the supply side, while the government has been able to maintain oil production capacity at about 4.2mn b/d in recent years, it has been unable to reach its planned target of 5.6mn b/d due to lack of access to modern oilfield technology, and insufficient investment. Not only has Iran lacked access to up-to-date oil drilling and recovery methods, but the country’s natural gas output has also been insufficient to meet the normal injection requirements due to rising domestic demand, exports’ commitments, and inadequate load-factor management. Consequently, the country has become short of gas in cold winter months, and a net overall gas importer on an annual basis. Moreover, the oil ministry’s puny annual investment appropriation in the national budget has in recent years been less than one-third of the estimated requirement for output growth. So, the increase from the current 4.2mn b/d capacity to 5.6mn b/d target requiring an estimated $18bn of new investment has been postponed time and again. Iran has also failed to meet its OPEC quotas from time to time.
At the same time, foreign sources of finance are fast drying up. According to a recent admission on the oil ministry website, Iran is “facing problems in financing oil industry projects” and unable to attract sufficient foreign investments in its oil and gas fields. With the exception of a recent agreement with Malaysia signed in early January 2007 to develop two offshore gas fields of Ferdows and Golshan, and two major memorandums of understanding with China’s Sinopec to develop North Pars offshore gas and Yadavaran oil fields in Southwestern Iran, and a couple of smaller agreements with CNPC, no new contract has been concluded with a foreign company in the last two years. Moreover, Japan’s INPEX has given up its leading role in the development of the giant Azadegan oil reservoir for obvious political considerations. Since the emergence of the nuclear issue, Washington’s intensified pressure on international banks and financial institutions, has forced them to reduce their cooperation with the Islamic Republic.
But aside from Iran’s growing international isolation and US sanctions, an equally effective factor in keeping foreign oil companies aloof has been Iran’s unattractive contract terms under the so-called “buyback” deals. Under this scheme, foreign firms become Iran’s contractors charged with developing oil and gas fields, and recoup their investment funds plus interest and profit in a five-to-seven-year period out of the proceeds. These contracts, designed to get around the Iranian Constitution’s prohibition of giving mineral concessions to foreigners, have been unpopular both in Iran and with foreign firms. Iranians have found the companies’ 18-20% returns “exorbitant.” The scheme is also shunned by foreign entities that prefer production-sharing agreements, and usually complain that returns fail to cover rising project costs.
In short, the problem on which principal and urgent attention should be focused is not Iran’s oil and gas reserves, but the Islamic Republic’s populist and wasteful energy policies. Resources are not a constraint; the failure to increase production capacity, and adopt right policies, is. According to the International Energy Agency, elimination of energy subsidies would reduce demand for electric power and oil products by 6% each, and gas demand by 13%. In any event the exhaustion of Iran’s oil exports within a decade resembles a fairly tale. There is no doubt that if the depletion problem becomes alarming – particularly if the price of crude oil declines precipitously – the government would surely get its acts together, and change its policies. There are already signs that the authorities are moving in that direction by planning to ration gasoline consumption next March, distribute “smart” ration cards to reduce demands, raise fuel product prices, and even soften the foreign investment’s economic climate by revising the buy-back regulations, extending the time frame, and allowing some “participation rights.”
The Nuclear Option
Assuming the unlikely scenario that Iran’s oil exports will vanish in 10 years’ time, the question of whether resorting to nuclear energy makes any economic sense, given the country’s gigantic natural gas reserves, will still arise. To be sure, Iran’s nuclear energy program has never been a matter of pure economics. A number of other considerations, including technical and scientific know-how, have always loomed large. Short of the 22gw of nuclear energy that the Shah’s government considered installing in a decade or so, nuclear power did not make economic sense then. And with a maximum of three 1gw nuclear reactors to be built by 2010, it does not make economic sense now. Given the insufficiency of indigenous nuclear technology, the continued need for borrowed know-how, a geologically earthquake-prone terrain requiring additional and expensive safety measures and environmental precautions, and relatively small proven domestic uranium reserves altogether make the cost per unit of electric power prohibitively expensive. Private estimates by nuclear physicists and industry analysts put the cost of an atomic reactor (including interest cost during the 7-10 year construction period) at five to six times that of a combined cycle gas turbines of the same capacity. By the same estimates, the cost of electricity generation from nuclear reactors would be four-to-five times the average tariffs now paid by natural gas users in various regions of Iran. The elimination of electric power subsidy and more efficient transmission methods alone would probably negate the need for two 1gw reactors.
A Final Word
Nothing said here is to question the Islamic Republic’s rights to conduct its nuclear program for political or security considerations. If Tehran wishes to pursue its fuel cycle program, within its obligations under the Nuclear Non-Proliferation Treaty, for any reasons – national pride, international prestige, advanced scientific research, security of fuel supply, or others – it should not be sanctioned. Sovereign rights and a national nuclear program are not the issues here. Economic justification for nuclear energy is.
1. For typical arguments see Roger Stern, “The Iranian Petroleum Crisis and United States National Security,” Proceedings of the National Academy of Sciences of the USA, December 26, 2006; Stanley Reed, “Surprise: Oil Woes in Iran,” Business Week, December 1, 2006; and Paul Rivlin “Iran’s Energy Vulnerability,” MERIA, December 22, 2006.