Opec fears Iran’s production ramp-up, but how fast will it really be?

Opec fears Iran’s production ramp-up, but how fast will it really be?
Caspian oil rig.
By Nicholas Watson in Prague April 19, 2016

To no great surprise, the latest Opec meeting in Doha on April 17 ended in acrimony as those two old foes, Saudi Arabia and Iran, remained at odds. Saudi Arabia insists Iran, now in the process of ramping up production after the easing of international sanctions, must be part of any production cuts to shore up prices, while Tehran believes it has the right to regain its market share lost over the last two decades.

Yet while Iran’s output is indeed rising quickly as oil in storage is depleted, many observers say getting more out of its existing fields and developing new ones will take significantly longer than Tehran hopes and others fear.

The oil price tumbled by the most in two months on April 18 after the meeting of 18 oil-producing nations, including non-member Russia, in the Qatari capital of Doha ended without any agreement on limiting supplies. Brent crude fell 7% at one point on April 18, but then recovered to trade at down 4.3% at $41.23 a barrel by midday.

Saudi Arabia’s Deputy Crown Prince Mohammed bin Salman was quoted by newswires as saying that the kingdom wouldn’t rein in production without commitments from other major producers including Iran, which wasn’t present at the meeting and has ruled out freezing for now as it looks to regain its pre-sanctions capacity of around 4mn barrels a day (b/d).

“As we're not going to sign anything, and as we’re not part of the decision to freeze output, we ultimately decided it was not necessary to send a representative,” the Iranian government said in a statement ahead of the meeting.

For many observers, the failure came as no great surprise, and promises to be a foretaste of things to come at Opec. “Iran desperately needs oil to rebuild its infrastructure, and to buy the stuff that the rest of the world has been able to buy. And Iran’s religious leaders want their take, too,” says Kim Iskyan, founder of Truewealth Publishing. “With these sanctions recently lifted, Iran now wants to export as much oil – and earn as much money – as it can. The last thing Iran wants (and which its president can politically afford to do) is to limit the amount of oil it can sell abroad.”

According to Chris Weafer, a founding partner at Macro-Advisory, Tehran’s position is that it has made the biggest contribution to production control as a result of the international sanctions imposed on its energy industry in 2007 (since 1995 in the case of the US). “That forced it to cut approximately 1mn barrels from the market and that helped the oil price to trade so strongly in 2011-2014. Tehran says that other Opec countries benefitted hugely from that reduction and they now ‘owe Iran’,” he says. “Its position, therefore, is that it is morally entitled to rebuild production and exports as fast as possible, and it is for the others to now adjust on a voluntary basis, as it did on a forced basis.”

Iran has set itself a target of 4mn b/d by the end of 2016, up from the roughly 3.2mn b/d achieved in March, and it has a goal of at least 5.7mn b/d by 2018. Though still a far cry from the 7mn b/d seen in the 1970s, for many even this looks overly ambitious given the sector’s lack of technical attention over recent years.

In the short term, Iran is raising exports quite quickly, thanks to large volumes of crude and condensates that are in storage. According to Petroleum Economist, the Israeli maritime-data consultancy Windward put Iran’s floating-storage levels at 47.8mn barrels at the end of January, while Iran has also tucked away millions of barrels of crude on Kharg Island. This could help increase supplies by between 200,000 and 300,000 b/d in the second quarter, it concludes.

But once existing storage has been drained, getting more oil out from existing fields will be a much more difficult task. New and brownfield projects this year, both onshore and offshore, could in an optimistic scenario add up to 300,000 b/d. But the net result, according to Elif Kutsal, a senior analyst for Energy Insights, is that Iran probably won’t reach the 4mn b/d output target until 2017-18.

New production will have to come from existing mature onshore fields that account for the bulk of Iran’s heavy crude. There is decent short-run potential at its the largest producing field, Ahwaz, though other mature fields will take more time and investment through enhanced oil-recovery (EOR) techniques before they can add much to the total – and that means attracting foreign investors with the kind of technology, knowhow and money to make a difference. However, for reasons of lingering sanctions, political ambivalence to foreigners and lack of clear investment rules, that remains a distant prospect for now.

Suspicious minds

President Hassan Rouhani has said Iran wants to attract as much as $50bn a year in foreign capital, much of which will need to go into raising oil production. However, the main problem is that while the US has got rid of secondary sanctions (ie. those that apply to non-US interests) after the nuclear deal, primary sanctions (ie. those banning US interests from engaging in business with Iran) remain in place. Furthermore, many foreign entities remain wary that secondary sanctions could be reapplied at anytime if the US deems Tehran to have breached the terms of the nuclear agreement or the new administration in January takes a tougher line over Iran.

On the Iranian side, investors are waiting to see what the new upstream licensing system, the Iran Petroleum Contract (IPC), will look like. The released “Principles of the New Contract Model” acknowledged many of the criticisms levelled at the previous buy-back contracts, as well as recognising the need for the kind of structural reforms necessary to encourage investment of approximately $185bn required over the next five years to modernise Iran's ageing oil and gas infrastructure.

The buy-back contracts were regarded by investors as too inflexible, capping cost recovery and remuneration. “[International oil companies] were previously expected to invest in the development of contract areas in the knowledge that any overrun beyond pre-determined budgets would be irrecoverable. This acted as a clear disincentive to invest in more risky or marginal prospects, particularly when combined with a limited remuneration structure that did little to reward enhanced productivity,” Dentons' oil and gas analysts James Dallas and Alistair Black wrote in a recent analysis of the IPC.

In addition, developers couldn’t book reserves and didn’t benefit if production exceeded targets, nor did they have any control over production because the state-owned energy company NIOC took over the fields once they had come on stream.

The IPC appears to address many of these problems, though the government won’t reveal the fine print until a bidding round for new contracts is held, possibly in May. There was a London event planned for February, but Iran pulled out claiming the UK didn’t issue visiting Iranians with visas in time, though some suggested there were still disagreements over the IPC at the top.

This brings up a final area of concern: how serious some parts of the Iranian leadership are about bringing in foreign investors. Although passed by the cabinet last year, the general terms of the IPC have been under attack by the conservative-dominated parliament, with critics saying it violates parts of the Iranian constitution.

Just as historical enmity makes any sort of deal between Saudi Arabia and Iran nigh-on impossible, internal squabbles makes any deal regarding foreign investors a long drawn-out process – no matter how sensible on paper it might seem.