Business | 2012 Iranian Oil Survey
by MATTHEW M. REED
09 May 2012 19:55
Purchasing trends, supply-demand projections don't bode well for Tehran.
[ overview ] The United States first sanctioned Iran in November 1979, ten days after American diplomats were taken hostage in Tehran. Since then, Washington has imposed a wide range of sanctions, with every U.S. president since Jimmy Carter citing Tehran's human rights record, support for terrorism, or nuclear pursuits as grounds for action. By comparison, the international community sanctioned Tehran only recently. Between 2006 and 2010, the United Nations Security Council adopted four rounds of sanctions against Iran after it failed to comply with Resolution 1696, which demanded that Iran suspend all uranium enrichment.
U.S. and U.N. sanctions through 2010 barred the supply of nuclear materials to Iran, froze assets related to its nuclear program, inhibited the development of conventional and unconventional weapons, and complicated or prevented a variety of commercial activities inside the country. Some officials were barred from travel and personally sanctioned. Iran's Revolutionary Guards came under increased scrutiny as well. But years of pressure and the convergence of American and international concern did not change Iranian policy through 2011. Repression continued to define the political order, especially after President Mahmoud Ahmadinejad's controversial reelection in 2009. Iran's nuclear program advanced in spite of sabotage and international apprehension.
Late last year, however, calculations changed. An alarming report released by the International Atomic Energy Agency in November -- combined with the collapse of Iranian-European relations weeks later, persistent threats from Israel, and frustration in Washington -- provided the impetus for the toughest sanctions to date. Iran's 2.2 million barrels a day (b/d) in crude exports suddenly became fair game.
New sanctions target oil
On December 31, 2011, President Barack Obama signed new sanctions into law. Iran's banking and financial sector were targeted, including the Central Bank of Iran, which handles the country's oil transactions. Banks and businesses around the world were put on notice. They could do business with the United States or Iran -- but not both. The White House also maintained the right to grant exemptions to those countries that significantly cut crude imports from Iran before June 28. Customers thus have an incentive to diversify their imports rather than totally sever them. The law does not specify what percentage a country must cut imports by in order to qualify for an exemption. But 15-20 percent seems to be the goal, judging by government and corporate statements around the world.
The 27-member European Union announced even tougher measures on January 23, 2012. After much wrangling between foreign ministers eager to punish Iran and economic ministers worried that manipulating the oil market could backfire, the E.U. declared it would ban all Iranian crude after July 1. Roughly 20 percent of Iran's exports in 2011 -- 450,000 b/d of oil -- would thus be forced to find new markets. Assets of Iran's Central Bank were frozen. And, most importantly, European insurance providers were prohibited from covering any tanker that carried Iranian oil. Europe is home to the world's largest protection and indemnity providers (P&I clubs), which cover an estimated 90 percent of all sea-faring tonnage. The impact of the reinsurance provision could be devastating, as importers -- state-owned and private -- struggle to arrange alternatives beyond July 1.
Now may be the perfect time to survey Iranian oil prospects for 2012. Contracts with Iran's biggest customers were settled just recently. We now know how much oil Iran can expect to sell to India and China, its biggest customers. Two months before the July 1 deadline, Europe shows no signs of wavering; the threat of total boycott looms. In anticipation of U.S. sanctions, some of Iran's most dependable customers are preparing to cut imports. Finalized contracts, public statements from once loyal customers, and new data suggest Iranian exports are shrinking ahead of summer. Exports will be cut dramatically after July unless there is a diplomatic breakthrough.
Iran's customers now fall into three broad categories: those that will totally boycott Iran, like the E.U.; those that will continue to buy Iranian crude but will assume greater risk, like China and India; and those preparing to cut imports significantly in order to avoid sanctions, including Turkey, South Korea, and Japan. Up to one-half of Iran's total crude exports could be affected.
The European boycott
The E.U. ban is already under way but incomplete. Many refiners are cutting imports before the deadline. Others are having trouble clearing payments for oil. France's largest oil company, Total SA, halted imports from Iran in December 2011, before the E.U. boycott was announced. According to Marlene Holzner, energy spokeswoman for the executive office of the European Union, E.U. data shows that Britain imported zero barrels of Iranian crude in the second half of 2011. Spain's largest refiners, Repsol and Cepsa, confirmed in March that imports were cut off in January and February.
There is little evidence that a loss of Iranian crude is hurting Greece, the most vulnerable economy in the E.U. A senior executive from the country's top refiner, Hellenic, told Reuters on April 5 that purchases of Iranian crude were halted because it was impossible to clear payments with blacklisted Iranian banks. It seems Italy is now importing the most Iranian oil of any country in Europe. But data revealed last month by industry body Unione Petrolifera showed that Italy cut crude imports from Iran by half in February from just one month earlier.
Shrinking markets beyond Europe
Outside the E.U., many customers are cutting imports by 15 percent or more. Last year, Japan imported approximately 316,800 b/d from Iran. On March 20, Tokyo qualified for an exemption along with ten E.U. member states after it cut imports by at least 50,000 b/d in 2012. Officials hailed the exemption at the time and hinted that further cuts are expected. The Japanese government has supposedly told refiners to slash imports from Iran by another 20,000 b/d.
South Korean authorities also expect an exemption soon. Data released by South Korean officials on April 23 showed that imports of Iranian crude in the first three months of 2012 were down 22.4 percent when compared to last year -- a loss of roughly 65,000 b/d. Consultations with the White House regarding an exemption have reached their "final stage," according to an energy ministry official quoted by industry source Platts.
The question of reinsurance looms largest for Japan and South Korea, two of Iran's major customers and most distant destinations. Both will need to find new insurers and may turn to their governments for help. Iran's petrochemical industry, which exported $12 billion in goods last year according to Iranian estimates, is now subject to the insurance ban. Tankers carrying Iranian crude oil will not be able to acquire coverage from Europe after July 1.
Iranian oil represented 62 percent of Turkey's total crude imports as recently as January. Such dependency, however, has not prevented the country's only importer from promising cuts. At the end of March, state-owned Tupras, which controls all of Turkey's refineries, announced it would cut Iranian oil imports by 20 percent this year compared to last. Imports from Iran have fluctuated this year: starting at 221,000 b/d in January; falling to 102,000 b/d in February; and rising to 270,000 b/d in March. Turkey imported more oil from Iraq, Libya, and Nigeria in February, thus proving that Turkey can buy elsewhere. Tupras's pledge remains in force and imports are expected to fall in April.
Turkey's break with Iran could be accelerated by renewed geopolitical tension. Turkish leaders directly challenged Tehran's interests this year by siding with Syrian rebels and criticizing Iraqi Prime Minister Nouri al-Maliki last month. The chances of any reversal will only grow more remote as the two countries compete for influence in the Middle East.
Like Tupras, Malaysia's national oil company, Petronas, announced in March that Iranian oil liftings would soon be cut. Petronas is active in Malaysia and South Africa. It is now making up for 50,000-60,000 b/d in lost Iranian crude with increased purchases from Saudi Arabia and the West African spot market.
New terms for top customers
India and China will remain Iran's top customers in 2012. Traders in both countries are maneuvering to avoid the tanker reinsurance ban which could affect refiners in Japan and South Korea. Reports suggest Indian sources might ultimately assume the liability risk of carrying Iranian oil if they can obtain about $50 million in coverage for every shipment. That is far short of the normal coverage of $1 billion, but Indian buyers hope that Iran's history of safe carriage and the shorter distances traveled between the two countries make the gamble worth it. New Delhi has yet to offer sovereign backing.
Chinese importers may have better luck. Zhang Shouguo, secretary-general of China Shipowners' Association, told Reuters on April 30 that the country's "government departments are studying the issue [of sovereign reinsurance].... We are paying great attention to this. The country has the need for oil and it's our responsibility to move the crude. But we need a solution from the government so we can avoid such risk." So long as tankers are reinsured, India and China will remain Iran's biggest customers. But, even then, the outlook is not ideal.
India imported 450,000 b/d from Iran in the first quarter of 2012, which is significantly higher than last year's average of 350,000 b/d. April data released by Reuters on May 8, however, shows that Indian imports of Iranian crude fell from 409,000 b/d in March to 269,000 b/d in April after new contract terms took effect and state-owned refiners began cutting imports. Market sources speculate that Mangalore Refinery and Essar Oil, India's top private importers, will also cut imports from Iran by at least 15 percent in the coming year, although contract terms are unavailable. Mangalore is on pace to buy only 120,000 b/d this year though it is contracted to purchase 142,000 b/d. Smaller refiners, like Hindustan Petroleum, are pledging cuts too. Payment problems factor into many reports.
Chinese liftings of Iranian crude were cut by one half in the first quarter of 2012, after negotiations stalled between the National Iranian Oil Company (NIOC) and Sinopec, China's largest, state-owned oil company. Sinopec cut purchases from Iran by 285,000 b/d between January and March. Liftings restarted in April after a new contract was finalized in March. Unfortunately for Tehran, the terms reflect last year's levels and do not allow Iran to "backfill" the Chinese market by selling more oil to make up for lost sales.
When confronted by Washington, Beijing can say that it cut oil imports significantly in 2012, although the decline was due to a breakdown of negotiations, not American pressure. It is unlikely that Obama will push for sanctions against Chinese state-owned companies, however, given that country's significant ownership of U.S. debt. And neither side wants to increase diplomatic tensions while China transfers power to a new generation of leaders.
There is still a chance that ad hoc Chinese imports could increase this year, so long as Iran discounts its oil significantly. According to the International Energy Agency's February report, China could push to fill its reserves if prices decline or "if distressed cargoes become available in the Asian market following tightening EU and US sanctions against Iran." Either way, Iran will profit less.
Sanctions could force Iran to store millions of barrels on tankers in the Persian Gulf. There is some evidence that this is happening now, and that storage on Kharg Island, which holds 23 million barrels, may be reaching max capacity. Other producers would shut in production. But as I wrote for Foreign Policy in January, "Chances are the regime will not curb production even if it temporarily lacks customers. Doing so is risky because the country's oil infrastructure is not in prime condition; after decades of sanctions, shutting in production could result in unforeseen technical failures, and future problems when trying to return to maximum output." Millions of barrels may be sold at a discount later this year because NIOC is afraid to shut in production.
Securing payments is also problematic. Iran has already been forced to make considerable concessions on some terms of sale. Now that payments are so hard to process, Iran accepts rupees for 45 percent of the value of its oil sales to India. Instead of selling oil for readily transferable currencies, as other nations do, Iran will now try to use rupees to import Indian-produced goods. On May 7, Iran's ambassador to the United Arab Emirates told reporters that the Islamic Republic is accepting yuans for some crude oil sent to China. Similar arrangements might be made in the coming months. Iranian traders have also relied on select Turkish banks to transfer funds in recent years, but even these channels are vulnerable. Deteriorating relations between Ankara and Tehran could prove decisive.
The regime's revenues could be compromised by domestic developments as well. Productivity is declining because commercial conditions in Iran make it hard to attract foreign corporations with the high-tech knowledge and equipment required for advanced oil recovery projects. The International Energy Agency estimates that Iranian production fell by 50,000 b/d in March alone. In its monthly Short Term Energy Outlook report, the U.S. Energy Information Administration (EIA) noted, "Iran's decline in output began to accelerate during the last quarter of 2011 and has continued. EIA believes that the acceleration reflects a lack of investment, which is needed to offset natural production declines."
The outlook is grim for Iran. Oil production now stands at 3.3 million b/d, which is 250,000 b/d less than last year's levels, according to the International Energy Agency. Official statements from governments and refiners, as well as the most recent data, suggest exports will be slashed this year along with government revenues. If the reinsurance ban is not lifted, even more crude exports could be jeopardized. In April, the agency's monthly Oil Market Report estimated that Iranian crude exports could be cut by 950,000 b/d by July. Most estimates now fall in the range of 800,000 to one million b/d.
Global spare capacity (the ability to quickly but temporarily pump more oil) is "quite modest by historical standards," according to the EIA's April 27 report on the availability of petroleum products outside Iran. This means any crisis -- political or natural -- could tighten the market with little warning. But generally speaking, the price outlook and supply-demand dynamics are discouraging for Tehran.
OPEC is producing at a 30-year high, even though Iran, the group's second largest producer, is exporting 200,000-300,000 b/d less than it did last year. "The cycle of repeatedly tightening fundamentals since 2009 has been broken for now," the International Energy Agency reported on April 12. Libya and Iraq are increasing exports rapidly to make up for lost Iranian supplies. Inventories are also growing around the world, signaling that the market is well-supplied. The agency estimated last month that global oil stocks rose by one million b/d in the first quarter of 2012, although prices are only just now starting to reflect this reality. This month, U.S. inventories rose to their highest level in 22 years. And in its March-April bulletin, OPEC said there was no risk of prices reaching the record highs of 2008.
U.S. and E.U. leaders are confident that the world oil market can absorb the loss of half of Iran's crude exports. There is no guarantee that high prices will insulate Iran from sanctions. In a few months, it may become clear that only a comprehensive agreement with the International Atomic Energy Agency can do that.
related reading | Iran Business Expert: 'Crisis Shaking Foundations of Social Order' | Oil Maneuvers on Eve of Atom Talks | Analyzing the Impact of European Sanctions | Iran Primer: The Oil and Gas Industry
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