Iran’s Oil Industry: A House of Cards?

At first glance, Iran looks like an energy superpower. It is the second largest oil producer in the Organization of Petroleum Exporting Countries (OPEC). It owns 11 percent of the world’s conventional oil reserves, second only to Saudi Arabia. It also sits on 16 percent of the world’s gas reserves, the largest reserve after Russia. With rising oil prices, Iran’s oil export revenues have increased steadily, from $32 billion in 2004, to $47 billion in 2006. Finally, its geographic position on the world’s most important energy corridor, the Strait of Hormuz, through which 40 percent of the world’s oil traffic passes, gives Iran the ability to disrupt the flow of oil to global markets.

A closer look, however, reveals that Iran’s energy sector is a house of cards. It is neglected, crumbling and underinvested. Many of its oil and gas fields are in dire need of foreign technical expertise to help reverse their natural decline. An analysis published last year in Proceedings, a journal of the National Academy of Sciences, asserts that, “Iran is suffering a staggering decline in revenue from its oil exports, and if the trend continues, income could virtually disappear by 2015.” Iran’s deputy oil minister, Mohammed Hadi Nejad-Hosseinian, confirmed recently that, “if the projects for increasing the capacity of the oil and protection of the oil wells will not happen, within ten years there will not be any oil for export.”

Oil may be Iran’s greatest strength, but it is also Iran’s greatest weakness. As such, the debate in the West on how to prevent Iran from developing nuclear weapons should focus less on the risky military option, or the seemingly ineffective diplomatic option, and more on a comprehensive economic warfare strategy that targets Iran’s energy sector. With oil exports accounting for half the government’s budget and around 80 to 90 percent of total export earnings, the surest strategy to bring down Tehran’s Islamic regime is to break its economic backbone.

A Precipitous Decline

In the mid-1970s, with a production level of more than 6 million barrels per day (mbd), Iran was one of the world’s leading energy producers. After the 1979 revolution, Iran’s fortunes reversed. Production plummeted to 1.5 mbd, and during the subsequent eight-year war against Iraq, Iran’s oil infrastructure was crippled further. Today, if Iran were to try to match its pre-1979 level, it would require at least $80 billion in investment. Moreover, its gas industry would require an extra $85 billion by 2030.

U.S. sanctions have ensured that Iran’s oil sector would not recover. President George W. Bush has renewed sanctions first imposed in 1995 by President Bill Clinton, citing the “unusual and extraordinary threat” to U.S. national security posed by Iran. These sanctions prohibit U.S. companies and their foreign subsidiaries from conducting business with Iran, while also banning the financing of development of Iranian energy resources. In addition, the 1996 Iran-Libya Sanctions Act (ILSA) imposes sanctions on non-U.S. companies investing more than $20 million annually in the Iranian oil and natural gas sectors. The 2006 Iran Freedom Act (IFSA) extended ILSA until December 2011. Thanks to these sanctions, investment has plummeted. Today, Iran produces only 4 mbd and exports 2.34 mbd, about 300,000 barrels below its OPEC quota. This shortfall represents a loss of about $5.5 billion a year.

The decline in oil and gas export revenues is amplified by growing domestic energy demand. To keep 70 million Iranians content, Tehran annually spends about $20 billion, or 15 percent of its economic output, to subsidize gasoline, natural gas, kerosene and electricity prices. These subsidies have spurred rapid growth in consumption, prompting 15 percent to 30 percent inflation, and sparking a full-blown financial crisis.

Iran’s dire economic situation has also impacted its lack of refining capacity to meet domestic need for gasoline and other essential refined petroleum products. Gasoline production stands at 10.5 million gallons a day, compared with a daily demand of 18.5 million gallons. With 43 percent of its gasoline imported, Tehran plans to curb demand by launching an unpopular, and potentially explosive, rationing system this year. For a regime that promised to bring oil revenues to every family, eradicate poverty, and reduce unemployment, the decline in oil revenues, coupled with austere gasoline rationing measures and the eradication of energy subsidies, could be dangerous for the survival of the Mullahs’ regime.

The economic crisis brewing in Iran is an opportunity for the West. Should the West decide to exploit this situation and ratchet the pressure on Iran’s crumbling energy sector, Tehran’s house of cards could eventually collapse.

International Pressure

The U.S. must increase its pressure on its European and Asian allies to step up cooperation to counter Iran’s efforts to develop weapons of mass destruction (WMD) by limiting the access of their companies to the Iranian market. Of course, this is easier said than done. According to the American Enterprise Institute (AEI), since 2000, foreign European and Asian companies have struck deals with Iran to the tune of $135 billion. Key European and Asian allies that are critical to global efforts to weaken Iran are currently opposed to financial sanctions against their companies.

European energy companies that do business in Iran, such as Royal Dutch Shell, the Spanish Rapsol, France’s Total, and Italy’s Ente Nazionale Idrocarburi (ENI), currently enjoy the backing of governments that view ILSA as an unlawful extension of U.S. policy beyond its borders. In 2007, Royal Dutch Shell and Rapsol announced their intent to sign a $10 billion deal for South Pars, the world’s largest natural gas field.

Developing Asian nations pose an even greater challenge for U.S. efforts to isolate Iran. Both the China National Petroleum Corporation and the China National Offshore Oil Corporation recently announced plans to develop major liquefied natural gas (LNG) projects, respectively in South Pars and in North Pars. China’s other major oil company, Sinopec, hopes to develop the Yadavaran oil field, which is expected to produce 300,000 barrels a day by 2010.

The most concerning news comes out of India, a country that is actually helping Iran alleviate its gasoline problem. It not only supplies some 15 percent of Iran’s gasoline imports, but an Indian business conglomerate, the Essar group, is negotiating the construction of a 300,000 barrel per day refinery in southern Iran. Two years ago, New Delhi also signed a $40 billion LNG deal with Iran. India’s domestic natural gas supply meets barely half its demand. Iran, which is geographically close to India, is a natural supplier. Tehran, which now wants to become India’s exclusive natural gas supplier, is pushing for the construction of a $7 billion gas pipeline deal that would connect the two countries via Pakistan. This would make one billion Indians dependent upon one of the world’s most radical regimes.

Any successful U.S. effort to block international access to Iran’s oil and gas resources must take into account India’s and China’s ravenous hunger for energy. Thus, Washington would be advised to encourage these nations to look to alternatives for oil in the transportation sector, and alternatives to natural gas for power generation. This includes a boost in renewable energy, expanded clean coal usage, and increased generation of nuclear power. This is why Congress and the Bush administration approved a landmark deal in 2006, giving India increased access to the global market for nuclear fuel and technologies to enhance India’s civil nuclear power industry, an unprecedented departure from America’s long-standing policy of non-proliferation. U.S. policy should also include incentives for China and India to tap their vast coal reserves as ideal surrogates for Iranian natural gas.

Keeping an Eye on Industry

Pressure on multinational energy corporations should not come only from America and allied governments abroad. Millions of Americans and other freedom-loving people worldwide can help weaken Iran’s economy by ensuring that private and institutional money is not invested in companies that do business with Iran.

Many of America’s leading banks and public pension funds are heavily invested in some 300 publicly traded international companies that do business with Iran. Some 20 years ago, a U.S.-led campaign of shareholder activism denied South Africa the funding required to sustain its apartheid regime. When public pension funds and other institutional investors divested from South Africa, the regime began to collapse.

To replicate that success against Iran, investors must have access to crucial information. Congress should require the Department of Treasury to publish a list of companies whose subsidiaries continue to make energy deals with Iran. It should also post the names of foreign companies that have more than $1 million invested in Iran’s energy interests. Finally, Congress should require Treasury to list the pension and retirement plans, mutual funds, and other financial instruments that hold investments in these U.S. and foreign companies. Such transparency would allow the public to pressure these institutions to deny resources to companies that work with Iran, thereby expediting the decline of Iran’s energy sector. In the interim, DivestTerror.org is a website the public can access until Washington publishes its own list.

In some cases, public pressure has already worked. In 2005, Halliburton opted to pull a subsidiary out of Iran after years of operating through a sanctions loophole. Last year, Inpex, a Japanese oil company, cut its stake in a $2 billion project to develop the Azadegan field, in the southwestern province of Khuzestan. Leading financial institutions like UBS and HSBC also curtailed dealings with Iran. According to the aforementioned AEI report, while the overall value of deals in Iran climbed from $21 billion to $47 billion between 2000 and 2007, the number of new deals fell from 101 to 18. Indeed, investors are growing more scrupulous about Iran investment.

Conclusion

Many opponents of an aggressive economic assault against Iran assert that efforts to cut off Iran’s oil exports will disrupt global markets, cause a spike in oil prices, and hurt Western consumers. Accordingly, in December 2006, the U.N. Security Council voted to only issue limited economic sanctions against Iran, but not its energy sector.

Considering the long-term risks associated with a nuclear Iran, higher prices at the gas pump should not drive any Western country’s Iran policy. No doubt, if Iran’s production falls, due to investors’ departure or a calculated decision by Iran to use the oil weapon and cut its production, there will be economic fallout. However, Iran will be the main casualty of any disruption. Additionally, in recent years, the U.S. economy has shown remarkable resiliency in the face of mounting oil prices and can withstand even higher prices. There is also a safety net in place. Most major oil consuming countries maintain massive strategic petroleum reserves in the event of a drop in supply. The U.S. alone has some 700 million barrels of oil in reserve – two years worth of Iranian exports.

To insulate the U.S. further, President Bush seeks to double the size of the American oil reserve in the coming years. The President also seeks to reduce America’s oil dependence through increased efficiency and to shift to alternative fuels. Applied in unison, these tactics advance the strategic goals of reducing global energy prices, protecting the West against supply disruptions, and limiting the flow of petrodollars to Tehran. This increased pressure on the Iranian regime could, over time, generate a much desired regime change. If Washington executes this strategy with expediency and determination, this outcome could be achieved before Iran becomes a nuclear power.