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Business | 2012 Iranian Oil Survey: Autumn Update

by MATTHEW M. REED

21 Sep 2012 23:03Comments

Production lowest in almost a quarter century; sanctions' true impact may not register for some weeks.

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Matthew M. Reed (@matthewmreed) is a Middle East specialist at Foreign Reports, Inc., a consulting firm based in Washington, D.C. The views expressed here are solely his.
[ analysis ] Iran's crude oil exports collapsed this summer after U.S. and E.U. sanctions came into effect July 1. According to the International Energy Agency, July exports sank to 930,000 barrels per day (b/d), compared to last year's average of 2.2 million b/d. Total oil production fell to 2.9 million b/d -- a low not seen since 1989. That same month, Iraq surpassed Iran in terms of total output, displacing its neighbor as the second-highest oil producer in OPEC for the first time in decades.

Exports rose to 1.1 million b/d in August after China, Turkey, Japan and other customers restarted liftings or increased volumes. Top customers have arranged for Iranian tankers to deliver oil. And maritime insurance -- retracted by E.U. firms on July 1 -- will be provided either by Iranian firms or the governments of importing countries. Exports should rise slightly in September and then remain steady but still well below the 2011 average. (For background, see my "2012 Iranian Oil Survey," published here in May.)

Official response inconsistent

Oil Ministry officials frequently dismiss sanctions. Mohammad Ali Khatibi is Iran's representative to OPEC and director of international affairs for the National Iranian Oil Company (NIOC). On September 16, he told Iran's Press TV that independent data showing a decline in exports was wrong and corrupted by "political objectives." In the same interview, Khatibi claimed Iran still ranked second in OPEC, although the organization's latest report suggests Iran now ranks fourth in terms of production, behind Saudi Arabia, Iraq, and Kuwait.

OPEC publishes independent data and government statistics every month and the gap between these two numbers is revealing. In August, Iran reported that total production stood at 3.75 million b/d -- about one million b/d more than the International Energy Agency's estimate and secondary sources published by OPEC.

Oil Minister Rostam Ghasemi was equally defiant when he visited the Majles on September 19. "We have no problem selling our oil," he said according to the Mehr News Agency. "Iran's crude oil exports are increasing. With the increase in exports, the way has been paved for more currency income."

Other officials have acknowledged the challenge posed by sanctions. "There are some problems in selling oil and we are trying to manage it," President Mahmoud Ahmadinejad told state television on September 4. "The enemy has started an all-out war by initiating a psychological war, blocking the sale of oil and transfer of currency and banks and the Central Bank," he said. Mahmoud Bahmani, the head of the Central Bank of Iran, is now dealing with a currency crisis that has cut the value of the rial in half since the beginning of this year. He speaks often about Iran suffering from a "full-blown economic war."

Most revealing of all was Ayatollah Ali Khamenei's address to a group of scientists in late July, which was broadcast by state television. Khamenei argued that Iran must diversify its economy so that it is more resilient. "Generating wealth by selling natural and limited resources, such as oil, is not advancement," he said. "We have fallen into this trap."

Oil revenues usually constitute half of the government's budget and 80 percent of the country's foreign revenue earnings. Iran's crude exports, though abysmal in July, are set to recover slightly in the short term, but volumes will settle well below last year's 2.2 million b/d average.

Top customers import less

China continues to be Iran's most reliable customer. After overcoming a contract dispute in March, which cut Chinese imports of Iranian crude by more than 200,000 b/d for three months, export volumes returned to near normal. Oil is now being shipped on Iranian tankers and Beijing has accepted limited insurance coverage from firms inside Iran now that E.U. insurance is unavailable.

China imported only 456,342 b/d from Iran in July -- when exports flirted with record lows -- but the dip is not indicative of a larger downward trend. In fact, it most likely reflects the time required to transition from the old arrangement to the new, which relies heavily on Iran. Imports should hold around the 510,000 b/d mark in the coming months.

Compared to last year, however, China is on pace to import about 15 percent less oil from Iran. The decline is a direct result of the contract dispute and not Western sanctions. In June, China received a waiver from the United States because it imported significantly less oil in the first quarter of 2012. Come December, when the waiver is up for renewal, President Obama will likely extend Beijing's waiver based on broader "national security" interests instead of further reductions, which sanctions law permits.

Indian imports of Iranian crude are also down and will remain so through next year. India imported 350,000 b/d on average last year. In July, imports fell to 201,860 b/d because of sanctions and a mismatch between Iran's national tanker fleet and the shallower ports used by Mangalore Refining. The government-owned refiner sought alternative supplies throughout the summer, which suggests shipping is still a problem. India's privately owned Essar Oil may have better luck bringing in Iran's larger tankers. But the best-case scenario is still grim. Platts, a respected industry reporting service, says Indian refiners -- both state-owned and private -- expect to import just over 200,000 b/d through this fiscal year, which ends next March.

Asian customers make new arrangements

Japan imported 205,000 b/d from Iran in the first seven months of 2012, which represents a stunning 39 percent decrease from the same period a year before. In July, Japan halted all imports of Iranian crude for the first time since 1981 because of sanctions. Loadings rebounded in August after Tokyo extended a $7.6 billion government-backed insurance policy to tankers carrying Iranian crude; preliminary shipping reports suggest Iran will export about 170,000 b/d to Japan in September. On September 14, Washington extended Japan's sanction waiver along with those for ten other countries with the expectation that imports will remain lower than last year's.

South Korean imports of Iranian crude are also down. In the first six months of 2012, South Korea imported 189,000 b/d from Iran, as opposed to 230,000 b/d during the same period in 2011. Seoul initially claimed that it would have no choice but to halt imports from Iran because of the E.U. ban on tanker reinsurance, and officials say liftings were suspended in August. But South Korea ultimately adopted the riskier Chinese model, which allows Iranian tankers to ship crude insured by unproven Iranian firms. Imports will recover in September but will still be short of last year's volumes.

Other buyers find alternatives

South Africa imported 67,000 b/d from Iran in May but has not imported any crude since. Refiners in South Africa, which include Shell, BP, Total, and Chevron, easily replaced Iranian oil this summer because the volumes were limited. It remains to be seen whether or not Iran will offer appealing discounts to other refiners, like Petronas, which also operates in South Africa but is owned and operated by the Malaysian government.

Turkish imports of Iranian crude are best described as erratic. In March, Turkey imported a remarkable 270,000 b/d from Iran, while as recently as July, Turkey imported only 48,000 b/d. Preliminary data from shipping sources indicates that Iranian crude exports rose again in August to 173,000 b/d, which lines up closely with Turkey's 2011 average. All Turkish imports of Iranian crude are handled by Tupras, the country's sole refiner, and its annual contract with NIOC expired in August. Iran's oil minister planned to visit Turkey early last month, presumably to negotiate a new contract, but his trip was canceled with no explanation.

When Turkey's imports of Iranian oil dropped below 50,000 b/d in July, Tupras purchased oil from Iraq, Russia, Libya, and Saudi Arabia to make up the difference. On September 19, Turkish Energy Minister Taner Yildiz told the press that Turkey's imports of Iranian crude would be limited this year and that a new long-term agreement would soon be reached with Saudi Arabia. Turkey received a U.S. sanctions waiver in June and Ankara has committed to a 20 percent reduction in Iranian crude imports this year. U.S. Treasury Undersecretary David Cohen, who is tasked with the Iran sanctions portfolio, visited Turkey earlier this month.

Legal and illegal schemes

Iran has adopted a number of illegal and legal schemes in an effort to avoid sanctions. Speaking on August 23 in a national broadcast, Ayatollah Khamenei reminded officials that it was their duty to dodge the "enemies' plots." "Remember all the time that the enemies will not stop their enmity and they will try to resort to new measures after each failure. Therefore, the officials should find new solutions and measures all the time," he demanded.

Earlier this year, analysts began using Iran's tanker fleet to measure how much crude oil was being stored instead of sold. Because commercial tankers are no longer accepting Iranian cargoes and customers have reduced imports, it was assumed that Iran would have to choose between storing oil on its own tankers or shutting in production because its land-based storage was so modest. (Production in Iran declines naturally every year because the country lacks the necessary technical expertise and equipment for advanced oil recovery. These conditions would make any manager less inclined to shut in production, since restarting it could be tricky, perhaps even impossible without the help of foreign operators.)

To some extent, Iran has sidestepped this dilemma by dumping oil on unused tankers in far-off Asian waters. On September 12, the International Energy Agency reported that Iran's floating storage actually declined by five million barrels in July, confirming that Iran found new outlets for oil the same month that exports fell to near-record lows. These ship-to-ship transfers undermine sanctions in two ways. First, if the oil is blended with other crudes, the ship can mask the original source and potentially sell Iranian crude under a different national brand. And second, it appears that some European firms have unwittingly covered these tankers in spite of the E.U. ban.

It must be noted that this arrangement may not last. According to Reuters, the British government warned insurers about it in August. Trade sources say Iran is "struggling to find ship owners willing to offer vessels for storage" and that investigations are under way. With good reason, many ship owners are reluctant to do business with Iran, not only because they face stiff penalties, but also because their reputation could be damaged.

Earlier this summer, Iran reportedly disguised some tankers by redubbing vessels with English names. The Sima, Honar, and Davar thus became the Blossom, Victory, and Companion. Iran also shut off ship transponders that allowed for independent monitoring. And many tankers were reflagged so that observers might confuse Iran's ships with those from other nations. Industry sources have consistently dismissed these tricks, however. The U.S. Treasury Department now offers comprehensive listings of Iranian vessels that include original names, new names, known flags, and hull numbers, which cannot be forged.

Iran has taken the extraordinary step of accepting payments for oil in foreign currencies as well. In India, for instance, 45 percent of Iran's crude oil sales are paid for in rupees. Proceeds from oil sales are deposited into accounts, the balance of which is used by Iran to pay for Indian goods. Instead of receiving harder currencies in return, Iran imports food, pharmaceuticals, cooking oil, steel, and other items. Similar reports suggest that Iran is now accepting yuan for some exports to China. While this arrangement is perfectly legal, it is not ideal, especially when Iran's currency could be uplifted by the introduction of harder currencies. Most oil is paid for in euros or dollars.

Outlook

July was the worst month for Iran but exports should rise by the end of September now that new shipping arrangements are being smoothed out. Exports will probably settle into the 1.2-1.4 million b/d range for the remainder of 2012, after briefly falling below one million b/d. In today's prices, a loss of one million b/d amounts to $110 million every day -- and more than $3 billion every month. American sanction waivers are up for renewal at the end of this year, meaning Iran's customers will again be asked to reevaluate and reduce crude imports.

Most fortunately for Tehran, dramatic export declines were offset by a surge in prices. Brent crude, which is used as a proxy for world oil prices, sold for $95.16 in June -- but then jumped to $102.62 in July and $113.36 in August. Remember also that the terms of credit extended to Iran's customers allow some to pay up to 60 days later. This means that Iran only began counting diminished revenues this month, since sanctions were locked in July 1. Iran's leaders may not fully understand the impact of sanctions for weeks. It may take several more months for Tehran to seriously reconsider its nuclear posture, which sanctions aim to change.

In the meantime, international pressure or accidents could reduce Iran's oil exports even more. The U.S. Treasury is fully engaged in a global cat-and-mouse game with Iran. In addition, new American and European sanctions are being considered. It is also possible that Iran's many schemes could fall apart. Asian customers are now largely dependent on Iran's tanker fleet, which is insured by the privately owned Kish P&I, an Iran-based firm that offers limited coverage. Kish relies on the state-run Central Insurance of Iran as its reinsurer, however, and its ability to pay in case of disaster is uncertain. Any failure or delay in payment would force customers to reassess the risk of dealing with Iran. Some might even abandon Iranian crude altogether.

In short: Iran has stopped the bleeding but remains vulnerable.

related reading | Industry and Trade Minister: Western Sanctions 'Paralyzing' Iran | A Tale of Two Oil Shocks: 2007-12 | Iran Primer: The Oil and Gas Industry | Iran Primer: Oil and Gas Charts

Photo: Iranian Oil Minister Rostam Ghasemi (right) and Mohammad Forouzandeh (left), head of the Bonyad-e Mostazafen va Janbazan, or Foundation of the Oppressed and Disabled, Iran's second-largest commercial enterprise behind the state-owned National Iranian Oil Company.

Copyright © 2012 Tehran Bureau

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