Iran: stuck between Iraq and a hard place

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By Palash R. Ghosh | July 1, 2010 6:04 AM EST

Oil giant and international pariah Iran is facing a multitude of problems – both external and internal – that threatens the growth of its all-important energy sector.

Two European oil producers – Total S.A. of France and Repsol YPF of Spain – are but the latest of a series of Western companies that have elected to cease doing business with Iran, in response to  concurrent sanctions directed by the U.S., U.N., and the European Union against Tehran's incipient nuclear program.

Specifically, Total announced it suspended its sales of gasoline and refined products to Iran, while Repsol declared it will no longer participate in a project to develop the large South Pars gas field in southern Iran.

A spokesman for the French foreign ministry praised Total's decision, citing that it "illustrates Iran's growing isolation." Other major European oil firms, including BP, Royal Dutch Shell, ENI and Statoil, have already left Iran or are planning to exit.

However, even without international sanctions, Iran's national petroleum industry is falling apart anyway, as reflected by its plunging export figures.

According to Iran's own Fars news agency, the nation's oil exports dropped by more than 24% (or about $20-billion) in the most recent fiscal year. Iran retains its place as OPEC's second biggest oil producer behind Saudi Arabia, but Iraq -- where foreign oil companies are scrambling to build energy projects of enormous potential -- is bidding to replace its ancient Persian enemy for the No. 2 slot.

Indeed, according to Mehrdad Khonsari of the Center for Arab and Iranian Studies in London, Iran's oil exports have actually been steadily declining since the 1979 Revolution which ousted the West-backed Shah and established an Islamic republic.

While Iran's president Mahmoud Ahmadinejad continually downplays the threats posed by foreign sanctions, his country's oil infrastructure deteriorates.

One of the nation's many problems is that Iran suffers from a persistent shortage of refining capacity, according to Terry Hallmark, director of political risk and policy assessment at IHS in Houston.

"They seriously lack new technology as well as the ability to keep up proper maintenance, and their refining infrastructure is sub-standard," he said. "They can't adequately refine the heavier grades of crude that comprise a significant part of their oil exports. In addition, the Ahmadinejad regime has created few, if any, new strategic energy projects."

Iran's biggest heavy-grade oil customers are China, Japan, India, South Korea, Italy and Spain, Hallmark noted.

"Japan was their principal buyer for many years, but China has overtaken them," he said.

But, according to press reports, some of these Asian countries are seeking to reduce their formal term contracts with Iran in favor of other exporters who offer lower prices. According to the International Energy Agency (IEA), China's oil imports from Iran have been cut in half between January 2009 and January 2010. They may also be partially caving in to the U.S. which seeks to isolate Iran until it halts its nuclear program.

An international oil glut, including very high OPEC supply, exacerbates Iran's oil marketing woes.

Incredibly, Iran also needs to import about 40% of its gasoline needs, due to extremely high domestic demand.

Also, European insurance companies Lloyds Banking Group plc (NYSE: LYG) and Munich Re will no longer insure cargo in and out of Iran. Even some Indian companies like Reliance Industries Ltd. have been pressured by the US to cease doing business with Iran. A planned Iran-Pakistan-India gas pipeline is now in jeopardy.

And worse, due to draconian sanctions, Iran cannot obtain trade finance with foreign trading houses, severely limiting their plans to expand refining endeavors or borrow much-needed equipment and technology to upgrade their energy infrastructure.

The IEA predicts that Iran's oil-pumping capacity will fall by about 18%, or 700,000 barrels a day, from present levels to 3.3-million barrels a day by 2015. Should this come to pass, within five years, Iraq's expected oil production will exceed Iran's.

However, all is not bleak -- Iran recently signed agreements with Brazil and Turkey to develop gas-export projects, and, more importantly, Iran has received multi-billions in investment from Chinese-owned companies. Iran also enjoys close links with Russia.

Indeed, China and Russia may be Iran's trump card -- these behemoths have usually rejected UN sanctions against Iran.

Hallmark is not convinced that Iran's remaining customers will buckle under to UN pressures. "These countries have their own self-interests," he said.

"China has an insatiable demand for commodities, especially oil. Even if they reduce their consumption of Iranian oil, it's unlikely that they will stop it completely."

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