U.S. puts squeeze on Iran's oil fields

A campaign to dry up financing for projects poses a threat to Tehran's ability to maintain exports, analysts say.

By Kim Murphy

Los Angeles Times

January 7, 2007

LONDON — As Washington wages a very public battle against Iran's quest for nuclear power, it is quietly gaining ground on another energy front: the oil fields that are the Islamic Republic's lifeblood.

Iran's oil industry has raked in record amounts of cash during three years of high oil prices. But a new U.S. campaign to dry up financing for oil and natural gas development poses a threat to the republic's ability to continue exporting oil over the next two decades, many analysts say.

The campaign comes at a moment of unique vulnerability for Iran's oil industry, which also faces challenges from rising domestic energy consumption, international isolation, a populist spending spree by President Mahmoud Ahmadinejad and trouble closing contracts with foreign oil companies — a recipe for potential disaster in a nation with one of the world's largest reservoirs of oil.

"If the government does not control the consumption of oil products in Iran … and at the same time, if the projects for increasing the capacity of the oil and protection of the oil wells will not happen, within 10 years, there will not be any oil for export," Mohammed Hadi Nejad-Hosseinian, Iran's deputy oil minister for international affairs, said in a telephone interview.

If Iran were to suddenly stop exporting its 2.6 million barrels of oil a day, such as in the event of a military strike, world oil prices probably would skyrocket. But a gradual decline might be offset by other OPEC members, analysts say, particularly as Iraq increases its oil production and Saudi Arabia carries out plans for significant increases in its production capacity.

The efforts by the United States and its allies over the last few months to persuade international banks and oil companies to pull out of Iran threaten dozens of projects, including development of Iran's two massive new oil fields that could expand output by 800,000 barrels a day over the next four years.

"Many European banks which had accepted financing some oil industries projects have recently canceled them," Nejad-Hosseinian said.

In addition, banks are no longer granting letters of credit for delivery of some supplies, ministry officials say. And as nations such as Japan begin to back out of Iran oil development under U.S. pressure, the government in Tehran is being forced to dig into its own reserve funds to get crucial new projects off the ground.

But Nejad-Hosseinian said Iran had recognized the gravity of the threat and launched steps to head it off, including new "smart" rationing cards, scheduled for distribution in March to check skyrocketing sales of cheap gasoline, and an overhaul of Iran's historically stingy contract terms in an attempt to lure big oil companies into skirting the U.S. roadblocks.

Iran also is hoping to turn to China and Russia for help. But U.S. officials already have warned that they will seek to hold China accountable under Washington's unilateral sanctions laws if it proceeds with a $16-billion project to develop Iran's North Pars gas field. China also has signed a memorandum of understanding under which it may take on development of the Yadavaran field in southwestern Iran, expected to boost production by 300,000 barrels a day.

Domestic problems

Iran's oil and natural-gas dilemma has no direct connection with the sanctions adopted last month by the United Nations Security Council, which are narrowly aimed at assistance to Iran's nuclear program. Although Tehran insists it has strictly peaceful intentions, the U.S. and others believe the program is linked to development of nuclear weapons.

Rather, the looming crisis stems from a series of domestic problems that have converged at a time when Iran is susceptible to U.S. attempts to capitalize on them to coerce Tehran's compliance on the nuclear issue.

First is the condition of Iran's aging oil fields, which have never fully recovered from damage inflicted during the Iran-Iraq war of the 1980s.

To maintain sufficient pressure to keep them pumping, Iran has to divert large amounts of natural gas that might otherwise be sold.

"You need billions of dollars invested in order to stand still — to avoid a decline," said Manouchehr Takin, a former Iranian petroleum geologist who is a senior analyst for the Center for Global Energy Studies in London.

Likewise, increased output from refinery construction is being outpaced by the swelling number of young Iranians with a fondness for gas-guzzling cars. Heavily subsidized gasoline is just 35 cents a gallon, a price that invites smuggling, and talk about raising the price has, until recently, gone nowhere.

Moreover, the country has one of the most extensive residential heating infrastructures in the world, with homes in the most remote villages warmed toastily with cheap natural gas.

Total domestic energy subsidies total $20 billion to $30 billion a year, Takin said.

"These subsidies are now costing the government roughly 15% of Iran's GDP. That should knock you over. That's a mind-boggling number," said Hossein Askari, professor of international business at George Washington University. "And the nub of the problem is that if you were to cut the subsidies, I think there would be riots in the streets."

Iran could be reinvesting in the oil and gas infrastructure, and it is to a degree, but Ahmadinejad also has diverted billions of dollars in oil revenue to social welfare programs, major infrastructure building programs in neighboring countries such as Afghanistan and importation of consumer products — to the consternation of many of those in his government.

Foreign investment

The heavy lifting in recent years has been left to foreign oil companies, which in the 1990s began working in Iran in substantial numbers for the first time since the Islamic Revolution.

U.S. sanctions in place since the seizure of the American Embassy in Tehran in 1979 have prevented U.S.-based oil companies from operating in Iran, but companies such as Royal Dutch Shell, France's Total and Italy's Eni have invested, some heavily, despite on-again, off-again threats by Washington to pursue sanctions against foreign companies under U.S. laws.

To a great degree, though, Iran has created its own woes by dragging out contract negotiations and offering only skimpy paybacks to foreign oil companies interested in building new production, industry analysts say.

"People have said that even with sanctions and all the rest, if Iranians want investment in their oil industry, what they need to do is offer decent terms, and whatever the sanctions, they would have companies flooding in," said one Western oil company official, who spoke on condition of anonymity.

"But the issue for us at this point is both political and commercial. The state of the country is such that it's just not the right time to be there."

That is the message Washington is trying to reinforce. For years, U.S. sanctions prohibited investments of more than $20 million in Iran's oil industry, but in practice, they were applied only to U.S.-based oil companies. But as the nuclear showdown has unfolded, and as it became clear the U.N. sanctions would not impose serious economic penalties on Iran, Bush administration officials decided on a different tack.

Envoys from the Treasury Department have approached international banks and companies, reminding them of Iran's record of financing militant Islamic organizations such as Hamas, in the Palestinian territories, and Hezbollah, in Lebanon, through the banking system and its defiance of U.N. resolutions on nonproliferation, and warning that investing in such a country may not be a good business risk.

Simultaneously, the Justice Department reportedly has opened investigations of several banks to determine whether investments in Iran violated U.S. sanctions laws. In late 2005, Dutch bank ABN Amro agreed to pay $80 million in fines stemming in part from improper transactions with Iran through its subsidiary in Dubai, United Arab Emirates.

UBS Bank and Credit Suisse of Switzerland recently announced they were suspending most new business with Iran, and British-based HSBC said it would no longer accept dollar transactions from within Iran.

"Banks are constantly doing risk assessments about what kind of business they want to be involved in," Stuart Levey, Treasury undersecretary for terrorism and financial intelligence, said in a telephone interview.

"There's a lot out there suggesting that there's an element of coercion involved. But I think that for a lot of these executives, the main thing driving them is they really don't want to be involved in facilitating terrorism or proliferation or any other crime."

More than two decades of U.S. sanctions have had little effect on Iran's oil industry — U.S.-based companies have been replaced, largely by Europeans. But this new attack on financing has rapidly started to dry up potential loans on dozens of projects, according to oil industry insiders in Tehran and the West.

One of them is reportedly the giant Azadegan oil field in southwestern Iran near the Iraqi border. Japan's INPEX Holdings Inc. in October pulled out of all but a 10% stake in the $2-billion project under U.S. pressure, and alternative financing from foreign banks has failed to materialize, said one source with close connections to the Iranian Oil Ministry.

"It has been very effective. Nobody is prepared to loan Iran anything on anything," said Fereidun Fesharaki, an energy advisor to the Iranian prime minister in the 1970s who now heads the FACTS Inc. petroleum consulting firm in Honolulu.

In a report published this month by the National Academy of Sciences, Johns Hopkins University geography professor Roger Stern argued that the confluence of high domestic demand, a delay in adding production capacity, the diversion of natural gas to keep wells producing and other factors could lead to a decline of 33% to 46% in Iran's exports by 2011 and a halt to exports by 2015 or so.

Other analysts have said those forecasts are too dismal, and output is more likely to remain flat at about 4 million barrels a day. Iranian officials say they have signed $28.4 billion worth of new oil and gas development contracts over the last 15 months, and hope to increase production to 7 million barrels a day by 2014 — a goal that the International Energy Agency says will require $80 billion in investments.

The nuclear issue

Whether that will be realized could depend, in large part, on what happens on the nuclear issue.

In fact, Iran's oil and gas dilemma appears to point up a "genuine" need for civilian nuclear power, Stern said.

"When I first started hearing this claim that Iran needed these nuclear plans to substitute for oil and gas, I thought, 'That's ridiculous,' " he said. "So it has really been a surprise to me," he added, to see evidence that Tehran's stated purpose for the nuclear reactor is not "simply a weapons deception."

"I don't think they're nice guys," he said. "This is a regime that funds terrorism and is making outrageous claims that Israel should disappear. But it just happens to be a convenient truth for them that they do need nuclear power."