An Impasse in the Iran Crisis


"Official Tehran continues to convey an impression that the sanctions are having no effect on either Iran's ability to sell its crude or entice foreign companies to enter into projects. However, the arguments are ringing hollow."

Marina and I made it home from the Bahamas late last night.

But, as you read this, I am already on another plane.

This one is heading for Houston and my meeting with officials from Nigeria.

As I've noted in the past, one of the many hats I wear in the oil world is a contributing editor for Thomson Reuters' Russian Petroleum Investor and Caspian Investor. These monthly energy publications go out to public and private sector decision makers worldwide.

Some of my policy-related market intelligence for immediate consumption can be found there, especially on developments with Iran, Iraq and the Persian Gulf.

Today I want to share with you an abbreviated version of what I released over the weekend in Caspian Investor.

What I talk about is going to have a decisive impact on the increasingly volatile oil market we will experience moving into the summer. The analysis also provides a glimpse into one of my "other lives."

And it can help you make sense of the best way to profit moving forward.

Sincerely, Kent

Iranian Talks Will Accomplish Little; Foreign Companies Experience Widening Problems

The upbeat statements coming from the conclusion of the Istanbul meeting between Western powers and Iran are unlikely to translate into any tangible success when the parties reconvene on May 23 in Baghdad.

Both sides have mandatory demands unacceptable to the other. Meanwhile, foreign companies still operating in Iran are feeling the rising bite of the sanctions.

False Optimism

Tehran is playing the high ground, at least for now. A series of upbeat statements coming from Iranian officials has placed a "positive" tag on the recently concluded first round of negotiations in Istanbul between Iran and the 5+1 group (the five permanent U.N. Security Council members—China, France, Russian, the UK, and the U.S.—plus Germany).

Alaeddin Boroujerdi, the head of National Security Council and Foreign Policy Commission of the Iranian Parliament, for example, announced on April 20 that Iran would negotiate with the major powers on the matter of cancelling the embargoes imposed on the country's banking system and oil trade.

The second round is now scheduled for May 23 in Baghdad. But while both Tehran and the world powers provided encouraging indications that the talks were progressing, the discussions are still likely to bog down once they reach the key demands on both sides.

According to Boroujerdi, the first round of talks has been "good and a step forward." Yet he expects the matter of eliminating the sanctions on Iran will be discussed during the second round of negotiations, which Tehran still anticipates will take place prior to the initiation of the European Union (EU) oil embargo on July 1.

"I suppose that the talks took place at all should be considered a plus," a U.S. policy contact told me on April 22. "Yet, the substantive separation remains wider than the Strait of Hormuz," a reference to the strategic Persian Gulf oil choke point now the focus of considerable geopolitical concern.

The Impasse

Iran is demanding the end to sanctions against both its international banking and global oil trade before it will even entertain discussions on its domestic nuclear program. Tehran continues to claim the program is only for peaceful energy purposes, while the West has concluded the enrichment levels being pursued are well in advance of power generation purposes and can only be needed for weapons development.

Meanwhile, Washington and Brussels are in agreement on three essential (and nonnegotiable) takeaways:
  1. An immediate cessation of all uranium enrichment programs (to both 20% and 3% levels);
  2. A withdrawal of the fuel already enriched to locations outside Iran; and
  3. The dismantling of the underground installation below Fordo outside the sacred city of Qom.

Contacts in Brussels are adamant that the EU will not accept the Iranian demand as a precondition for extending the talks. Meanwhile, a number of Iranian sources—including directors at the Tehran-based International Center for Energy Studies' OPEC Research Office, senior officials in the Ministry of Oil, media analysts, and members of the Majlis (parliament)—are unanimous in saying Iran will never agree to the last two Western demands and, in all probability, the initial one either.

Negotiations often begin with one or both sides making demands that are later mollified or dropped altogether. In this instance, however, the demands on each side are central to the essential and strategic position the party is obliged to defend. That means the "overture" being put forward by Iran is nothing other than a play for time.

"They cannot accept any of the European points without sacrificing their strategic position, and they have nothing of substance to provide as a counter-negotiating stance," a veteran Middle East analyst with Stanhousie Demant in Amman, stressed in an April 21 telephone conversation.

Faking Business as Usual

Official Tehran continues to convey an impression that the sanctions are having no effect on either Iran's ability to sell its crude or entice foreign companies to enter into projects. However, the arguments are ringing hollow.

For example, National Iranian Oil Co. (NIOC) managing director Javid Oji (who also serves as a deputy minister of oil) said on April 17 that the country is finalizing deals to export natural gas to a European and two Persian Gulf states. Yet, as in the past when such statements have been made by a variety of Iranian officials, Oji refused either to name the countries or provide any details. He did mention that gas would be exported to Europe across Turkey. Oji further said a decision to sell gas to Swiss EGL would require trilateral talks between the three countries involved.

The EGL connection, which has been on the table for a while, remains a potential problem, given the company's involvement in the Trans Adriatic Pipeline (TAP) currently contending with three others as a conduit for gas produced in phase 2 at the Azerbaijani giant offshore Shah Deniz field.

The Ministry of Oil is also once again touting a gas export agreement with Iraq. According to the deal, 25 million cubic meters a day would move to Iraq on a five-year contract that is subject to renewal for two additional five-year terms. The primary end users are intended to be electricity generating plants and industrial facilities.

However, sources in both the Ministry of Oil and the Ministry of Electricity in Baghdad are quick to point out the accord has not been finalized. "We have not even reviewed the initial wording of the governing protocol," one Iraqi source close to the negotiations told me earlier in April. Meanwhile, multiple contacts are indicating pressure has come from Washington to delay the project, especially since a Royal/Dutch Shell project is once again underway to utilize associated gas a fuel source for power generation.

Oji has also reported that gas reinjections into crude oil wells are increasing, The average daily rate has reached 12 million cubic meters, the highest ever achieved by the National Iranian Gas Co. (NIGC). This volume of gas was injected to Koupal, Korenj, and Maroun oil fields, and doubles the volume compared to the preceding year.

Yet the amount injected remains insufficient to redress already significant loss of pressure at the country's oldest fields, from which Iran still extracts the brunt of its oil bound for export. The ongoing issue has been raised in the Majlis on several occasions, prompting members of the standing energy committee twice to challenge both the ministry and the presidential administration on its ability to keep production from falling further because of an accelerating decline in reservoir pressure.

Problems for Foreign Companies

Sources throughout the foreign company contingent still in Iran are acknowledging across the board that Western sanctions are making business very difficult. In addition to the genuine concerns about facing reprisals against assets or projects in either the U.S. or Europe, there is the accelerating problem of restrictions against access to Western technology, expertise, equipment, and even spare parts.

This was certainly in evidence when this year's International Oil, Gas, Refining, and Petrochemical Exhibition opened in northern Tehran on April 17. This was the 17th edition of the annual affair. Contacts acknowledge some 75% of the participants were from Iranian companies, while foreign exhibitors were down about 40% from last year. Absent were main participants from past exhibitions, such as ENI, Royal Dutch/Shell, Total, Saipem and the main Western providers of oil field services.

Even those in attendance, representing a range of Chinese companies, along with foreign-Iranian joint ventures (most predating the sanctions) and a few holdouts (Statoil, for example), were providing little indication that essential technology or knowhow was available. Particularly lacking were representatives of companies providing the one thing perhaps most needed in the current Iranian climate – quality control.

Providers of specialized services, equipment, valves, pressure pumping and other products confirm that Western governments in general, and Washington, London, Paris, and Tokyo in particular, are preventing them from delivering high-tech equipment and parts to Iran.

"The [Iranian] market is rapidly reaching a point where projects cannot be adequately operated because access to essential equipment and support is lacking," the representative of a French-based technology provider admitted.

To some extent, this is providing a short-term opportunity for Asian service providers to establish a bigger foothold in Iran. Unfortunately for the official rhetoric coming out of Tehran these days, in which the refrain is often advanced that new foreign providers are replacing those prevented by Western sanctions from participating, this exchange of providers is not enough.

Asian service companies able to avoid current sanctions are able to satisfy some needs, but the specialized and technical expertise required to deal with the worsening operational, reservoir, and geological problems arising (especially at older Iranian fields) are provided by industry leaders subject to U.S. and EU restrictions.

This is requiring that the Ministry of Oil and NIOC rely on domestic providers. Except for the most straight-forward and uncomplicated service, parts, and support, this local reliance initiative has failed miserably. In several cases, it has worsened the field situation, forced delays on project completions or obliged that operations be suspended altogether.

Even when a way can be found to provide outside expertise without running afoul of the sanctions, there remains the problem of payment. Given the combination of limited access to international banking, severe currency exchange problems and a local currency whose value is disappearing (the "official" rate remains 3,200 rials to the dollar; the effective rate is closer to 12,500, but the ability to secure a bank transfer is extremely difficult at any exchange rate offered), requires that NIOC pay in kind.

That means companies are paid in crude oil. And with the EU embargo of imported Iranian crude set to take effect July 1, nobody knows whether such payment arrangements will be available.

"This is going to adversely affect any contract provisions beyond a few months or even beyond a single transaction," one regional market veteran told me on April 23, "even if the cumbersome Iranian negotiating process allows it."

Chinese companies were expected to profit from the worsening situation. For one thing, China has never recognized the U.S. and EU sanctions, preferring to restrict comment to its compliance only with decisions from the U.N. Security Council. Nonetheless, Beijing has been careful to refrain from directly antagonizing either Washington or Brussels. Playing both ends from the middle, Chinese companies have until recently believed they could establish major footholds in Iran without creating significant political problems elsewhere.

For another, China as the largest importer of Iranian oil has leverage. That it also runs a trade surplus with Tehran merely expands its bargaining power. The surplus effectively allows it to subsidize oil purchases with its own exports to Iran, significantly cutting the actual expense of the crude trade.

But neither caveat is helping when it comes to providing field services inside the country. There Chinese companies have rather noticeably of late cut their interest in attracting new contracts. Some have even suspended activities altogether. Company representatives have not made public statements on the matter, nor will my at Great Wall Drilling or Sinopec comment for the record.

Nonetheless, it appears clear that the Chinese are now facing the same problems as other potential providers. The Iranians are providing contract terms that are simply not viable.

Meanwhile, the official bravado continues. Minister of Oil Rostam Qasemi kicked off the oil exhibition with a speech highlighting what Iran has accomplished in defiance of the sanctions. He noted in particular that the country would secure the $200 billion necessary to accomplish the five-year plan due to end in 2015.

Vice-President Mohammad-Reza Rahimi also chimed in by announcing that Iran would soon sign deals worth $44 billion with foreign companies in attendance at the exhibition. As has been the case repeatedly in the past with similar statements of breakthroughs followed by nothing of substance, Rahimi declined to name either the companies or the projects.

Kent Moors
Oil & Energy Investor

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