Lukáš Tichý and Nikita Odintsov
Mr. Tichý is a research fellow at the Institute of International Relations in Prague, Czech Republic. Mr. Odintsov is an associate research fellow at the Institute of International Relations and a PhD candidate in the Faculty of Social Sciences at Charles University, also in Prague.
According to BP statistics, Iran has the world's largest reserves of natural gas and its fourth-largest reserves of oil. Its strategic geographic position makes it capable of supplying these resources to Europe, its Middle Eastern neighbors, and South and East Asian countries.1 Yet, the difficult geopolitical situation around its nuclear program and the poor management of its energy industry have prevented it from becoming a gas exporter to the European Union (EU).
However, the recent Joint Comprehensive Plan of Action (JCPOA) on the Iranian nuclear program and the promising reforms of the Hassan Rouhani administration have created hopes for invigorating Iran's export potential. Iran has not only declared that it plans to take back its share of the world oil market; it has also announced plans to increase its natural-gas exports.2 And as EU-Russian relations deteriorated under the influence of the Ukrainian crisis, Iran is seen as an alternative to Russian gas supplies.
Currently Russia's Gazprom is the largest gas supplier to the European market. After the gas crises of 2006 and 2009, when the supplies that were transported via Ukraine were interrupted, the reliability of Russia as the main exporter to Europe was undermined. At the same time, the European Commission (EC) accuses Gazprom of noncompetitive practices and promotes liberalization of the gas market. Hence, the long-term goal for the EU is to find alternative suppliers and build an internal market, ideally based on the spot-market principle instead of the long-term contracts preferred by Gazprom.
These disagreements led the EC and the European Parliament to study Iran as a possible alternative to Russia. After the JCPOA and the expected lifting of economic sanctions, European companies can return to Iran, and the EU might try to establish closer economic cooperation with Tehran on energy issues.
This article tries to address the question of whether Iran can indeed decrease the EU's dependency on imported Russian gas.
EUROPE'S ENERGY SECTOR
The EU is one of the world's largest consumers and importers of energy resources.3 Its domestic production is declining, and EU member states are becoming more dependent on countries outside the EU or from the non-EU countries in the European Economic Area (such as Norway). According to the EC, about 53 percent of overall energy consumed by EU countries depends on imports: about 90 percent of their petroleum is imported, and 66 percent of their natural gas.4 In the last 20 years, overall gas production in the EU has fallen by 56 percent, and now the member states import almost 300 bcm of natural gas each year. In the next decade, it will rise to 340-350 bcm/y.
Russia is the main energy supplier to the EU, with an oil and gas market share of about 30 percent.5 Yet disagreements about the fragmented nature of the market and uncertainties surrounding the reliability of Russia as a gas supplier have forced the EC to pursue a broad strategy to reduce European dependency, especially in the central and eastern member states. The bulk of this trade involves pipelines, and prices are determined by long-term contracts between Gazprom (or some non-Russian supplier) and the wholesale buyer in the consuming nation. These sorts of long-term contracts include a "take or pay" clause that obliges importers to buy an agreed-upon volume of gas or else pay a fine. Gas prices are linked to oil prices with a time lag of about six months.6 Though Russia argues that this arrangement secures the gas supply for a period of 20-30 years, according to a growing body of opinion in the EU, actively promoted by the EC, Gazprom can effectively manipulate the gas market at the expense of consumers, who have to pay a punitive contract price.7
Moreover, price disputes between the Russian Federation and Ukraine in 2006 and 2009, which resulted in the disruption of gas supplies to Europe, undermined Russia's reputation of a reliable supplier.8 The 2014-15 military conflict in Ukraine once again raised questions about the security of supplies. These issues are reflected in the 2014 European Energy Security Strategy, which states that "[t]he most pressing energy security-of-supply issue is the strong dependence [on] a single supplier."9 Therefore, "[t]he European Union must reduce its external dependency on particular suppliers […]."10 Russia, though not mentioned, is clearly assumed to be the referent.
As for remedies for this "external dependency," the EC proposes three strategic measures, already included in the EU's primary law: first, it encourages energy efficiency and greater use of alternative fuels; second, it actively pushes for diversification; and third, it promotes the creation of an internal gas market with a larger role for the EC in its regulation.11 The last point assumes a shift from a market based on long-term contracts to a spot market regulated by the commission.
Though there has been some progress on renewables in the energy mix of some member states, it is clearly not adequate to limit import dependency.12 Nevertheless, significant progress was achieved in the middle of 2009, when the EU adopted the so-called "Third Energy Package." It was, according to then-Commissioner for Energy Günther Oettinger, a crucial prerequisite for the creation of the internal gas market.13 The package presumes an increase in competitiveness through a dismantling of vertically integrated companies such as Gazprom (those that control upstream, downstream and transportation). The mechanism is called "unbundling." Under this provision an independent operator will provide, to a non-discriminatory third party, access to the transmission infrastructure.14
The rationale for this measure: if there are more traders on the market with access to the pipeline, the market will have higher liquidity, and competition will drive prices down.15 This logic led to the adoption of the non-binding but politically important Gas Target Model, which envisions a complete shift from a market regulated by long-term contracts — preferred by Gazprom — towards a spot market, where buyers can freely choose the source of gas.16 This will effectively deprive Gazprom of its ability to dictate contract terms and give the EC an instrument with which to regulate the market.
The enthusiasm for the active promotion of the spot market was a temporary gas glut that appeared just as the Third Energy Package was enacted. This other supply was a result of the so-called shale-gas revolution in the United States; LNG (primarily from Qatar) that was originally destined for the American market was poured into the EU at almost fire-sale prices. Furthermore, after the world economic crisis in 2008, overall consumption in the EU declined. The effect of these events was that spot-market prices fell, while Gazprom's oil-linked long-term contract prices remained high; consequently, its market share declined from 28 percent in 2008 to 23 percent in 2010. The low spot-market prices helped the EC to convince the energy-intensive industries and reluctant governments to support the transition to the spot market17
Thereafter, however, the situation stabilized. Due to higher demand for LNG in Asia, LNG supplies to the EU steadily declined, the gap between spot prices and Gazprom's long-term contract prices closed somewhat, and Gazprom recovered its market share.18 To continue the process of market integration and liberalization, it is necessary to ensure the liquidity of the spot market. For this reason, the search for alternative suppliers would be necessary even without the recent political tensions with Russia — though the current conflict accelerated this process. As some recent reports suggest, European officials are "quietly increasing the urgency of a plan to import natural gas from Iran, as relations with Tehran thaw while those with top gas supplier Russia grow chillier."19 Thus, according to an internal document prepared for the European Parliament, Iran can be "a credible alternative to Russia."20
IRAN'S ENERGY SECTOR
In spite of the fact that Iran sits on 33.8 trillion cubic meters (tcm) of natural gas (about 18.2 percent of the world reserves), it has been unable to fully develop its export potential. It exports less than 10 billion cubic meters per year (bcm/y) to Turkey, around 2 bcm/y to Armenia and only 0.5 bcm/y to Azerbaijan.21 This is caused by excessive domestic consumption of natural gas and the generally degraded condition of the Iranian energy industry. It is not well-balanced and is hampered by structural problems: underinvestment in the upstream sectors; poor management of the National Iranian Oil Company (NIOC); and the low energy efficiency of the economy, which is constrained by consumer subsidies.
The Upstream Sector: Oil
With the lifting of sanctions, Iran is planning to make a comeback on the world energy markets.22 Iranian Minister of Petroleum Bijan Namdar Zanganeh has already declared that NIOC plans to raise production to a pre-sanctions level (about 4 mb/d) and to regain its lost market share. Indeed, the sanctions imposed by the EU in 2010 and 2012 hit Iran's energy industry very hard, as Iran lost access to foreign capital, technology and European energy markets.23 Between 2011 and 2013 Iran experienced an almost 20 percent fall in its crude-oil production, and its exports were halved.24 According to the Russian Energy Research Institute of the Russian Academy of Science (ERIRAS) — which modeled the global energy outlook to 2040 — after sanctions are lifted, Iran will be able to increase its oil production up to 265 million tons (about 5 mb/d) by 2020. Subsequently, its production is bound to decline to 230 million tons (4.6 mb/d) by 2040.25
A decline in Iran's production capacity is inevitable since most of its oil fields are at a mature stage with high rates of natural decline.26 To maintain production levels, Iran has to enhance its oil-recovery projects, which involve significant quantities of gas and water reinjections. In 2008, the volume of gas reinjections was about 26 bcm/y, and was predicted to reach 64 bcm/y in 2015.27 However, according to available data, since 2011 the gas reinjections have actually never reached more than 60 percent of the projected targets.28 Until the imposition of the sanctions, petroleum constituted almost 80 percent of Iran's total export value; therefore, a priority should be to provide gas for reinjections rather than export.29
Natural gas accounts for 61 percent of the Iranian energy mix.30 In just the last decade, Iran's gas production doubled; it had increased eightfold between 1989 and 2014. Yet, this was accompanied by skyrocketing consumption as the mix shifted from oil to gas.31 Consequently, the rates of natural-gas production and consumption have been almost equal.Moreover, due to the unchecked consumption between 1997 and 2012, Iran became a net gas importer, buying gas from Turkmenistan.According to the Energy Information Administration, the recent drop in imports was a result of sanctions on financial transactions rather than increased domestic production or energy efficiency.32 Iran thus still struggles to satisfy domestic demand and is burdened by a large energy deficit.33
Nevertheless, when sanctions are lifted, Iran is expected to dramatically increase its natural-gas production. According to ERIRAS, it could make "the most significant contribution to increased global supplies of natural gas."34 In the period 2010-40, under optimal conditions, Iran could increase its natural-gas production almost 2.5 times, reaching almost 370 bcm/y, compared to the current 172 bcm/y.35 This will mainly depend on the pace of the development of the giant South Pars field in the Persian Gulf.
South Pars contains approximately 40 percent of the Iranian natural-gas reserves, and represents about 5 percent of global reserves.36 Given that the production capacity in most of the other operational fields has already peaked, successful development of South Pars is a strategic priority for the Iranian government.37 The whole project is divided into 24 phases with total costs exceeding $100 billion.38 Development is, however, behind schedule.39
Iran has completed the first 10 phases. Phase 12, with a capacity of 30.66 bcm/y, was launched in 2014; phases 15 and 16, with a total capacity of 20.44 bcm/y, were inaugurated on January 11, 2016.40 The next two phases — 17 and 18 (20.44 bcm/y) — are due to start production in 2016. The rest of the project will be finished only during the first half of the next decade.41 Obtaining assistance from international energy companies is crucial, but it has always been a problem.42 According to Minister of Petroleum Zanganeh, Iran "urgently" needs about $40 billion for the South Pars project.43 Even before the 2010 sanctions, however, when European companies were banned from investing in the country's oil and gas industry, Iran struggled to attract the necessary foreign investment.
Besides the gas shortages on the domestic market, the delays in the South Pars project led to an insufficient amount of gas for reinjections, which led in turn to a failure to meet oil production targets and Iran's OPEC quota.44 The lifting of economic sanctions is, however, a necessary but not sufficient condition for ensuring the access of foreign direct investment to Iran's energy sector and boosting its production. The mismanagement of the Iranian energy industry, the unfavorable investment climate and high subsidies for energy consumers are long-term problems the current Rouhani administration has to address.
Mismanagement and Foreign Partners
Contrary to public perceptions, Iran has significant political pluralism.45 Yet this has a negative impact on the development of a clear energy strategy.46 There is little delegation of power in the energy industry, leading to interference from various political actors. A common problem in many oil-producing states is that national oil companies are, on the one hand, under pressure to increase their investment in the development of energy resources and, on the other, to provide the government with finances for social programs at the expense of the company's budget.47 Thus, members of government who are also oil company executives find themselves in a dilemma.
The president and vice president of Iran preside over the general assembly of NIOC, which determines the company's budget and the general direction. The minister of petroleum, as chairman of NIOC's board of directors, implements its policy. NIOC's budget is then approved by the Ministry of Planning and the Majlis. Members of parliament can promote their own political agenda and are often engaged in political infighting with the incumbent administration. Moreover, as NIOC's budget has the status of law, the Guardian Council may check its consistency with Islamic law. The final outcome is thus a compromise between various political actors.48
Similarly, the frequent reorganization of NIOC's structure has had a negative impact on its performance. For example, the result of President Ahmadinejad's battle against the "oil mafia" (supposedly connected to Hashemi Rafsanjani, a former president and one of Ahmadinejad's rivals) was that the Revolutionary Guards with their affiliated companies gained significant control over the oil and gas industry, with a negative impact on its efficiency.49
Despite the fact that Iran needs foreign investment and technology, this politization and Iran's poor investment climate prevent the building of strong relationships with international oil companies (IOCs). In 1990, Iran made a strategic decision to open its energy sector to international investors and introduced buy-back contracts. As Paul Stevens explains, this decision reflected "its concern that the sector was falling behind" and was an attempt to break the country's isolation.50 Although some European companies have entered the Iranian market since then, the conditions that were offered by the Iranian government were not attractive enough for most foreign investors.
According to the Iranian constitution, only the state can own the country's natural resources, and Iranian law does not allow production-sharing agreements.51 Instead, Iran utilizes buy-back contracts, like service contracts whereby IOCs operate with a fixed rate of return in a payback period of between five and seven years and cannot book the reserves, which means that they cannot claim the share of hydrocarbons among their assets and thus cannot raise capital against these reserves.52 IOCs have to invest their own capital and expertise for the development of oil and gas, but when the production is launched, NIOC takes operatorship and repays the capital costs through the profits.53 In addition, the Majlis has become involved in the monitoring of the buy-back agreements, bringing domestic political considerations again into the relationships with foreign partners.54 Despite the fact that Iran has changed the structure of the buy-back contracts several times, this scheme has never provided enough incentives for the IOCs to massively invest in the upstream sector. Up to the imposition of EU sanctions in 2010 and 2012, only a few contracts for oil production were struck.55
Iran is planning to introduce new terms for the buy-back contracts that will be closer to the more typical production-sharing agreements in the industry. It is expected that under the new terms, the IOCs would be able to establish joint ventures with NIOC to "manage oil and gas explorations, development, and production projects,"56 and that investment risks will be more equally distributed.57 However, the Iranian Oil and Gas Summit, where the final draft of the new contracts was supposed to be presented in late February, was canceled.58
Besides the setbacks in the upstream industry, energy inefficiency caused by massive consumption subsidies, especially for gas, also limits Iran's export potential.59 Since gas prices have been kept much below the world level,60 consumption "grew significantly more than average annual GDP (4.1 percent) and at almost the same rate as production (9.5 percent)."61 In 2010, President Ahmadinejad tried to improve the situation and introduced a major subsidy reform. By 2015, individual consumers were supposed to pay 75 percent of the export price, and by 2020, industrial consumers were to pay 65 percent. Yet, in order to limit the impact on individual consumers, the government provided partial compensation of about $18.20 per household, about 50 percent of the amount earned after the subsidy cuts.62 Moreover, "in the three years since the reform, energy prices remained fixed, declining in real terms by over 60 percent."63 President Rouhani is also trying to improve the situation by continuing the subsidy reforms.64 Thus, the prices of petrol and gas for domestic and commercial consumers increased by 43 percent and 15 percent, respectively.65 Nevertheless, despite recent progress, overall gas consumption will increase: the government plans to provide gas for three million households and 19,000 industrial units by 2018.66
The country's power generation also depends heavily on natural gas — about 70 percent. In the last 10 years, power-generation capacity has almost doubled and further growth is projected.67 Yet the growth rate might not be as steep as in previous decades. Besides the subsidy cuts, the government has set itself the goal of decreasing the energy intensity of the economy 50 percent by 2021. Today, waste reportedly accounts for about a quarter of all energy consumption in the country.68 Thus, if the government's plan is successful, Iran's export potential will be significantly improved. Since similar plans were announced by the previous administrations with no meaningful progress, skepticism persists.
As Jalilvand notes, Iran has "adopted a series of conflicting policy goals during the last few years."69 It allowed for a rise in domestic gas consumption while it was presenting ambitious export goals for itself. Similarly, its focus on oil production will divert more gas into reinjection rather than export. As for today, the national priorities of the Iranian gas industry are ranked in the following order: "firstly, domestic consumption; next, reinjection in the maturing fields, and only thirdly exporting gas."70
Of course, the aforementioned discussion of strategic thinking (or the lack of it) in the energy industry suggests that these priorities are far from certain. Nonetheless, if the estimates for reinjections are correct, the volume of gas available for export will be very limited despite the considerable growth in production. In 2015, the reinjections are supposed to reach 64 bcm/y.71 Iran also plans to finish phases 15 and 16 of South Pars in the same year. Together with phase 12, launched in 2014, they will produce about 50 bcm/y — not enough to cover the rising volume of reinjections in the same years.
The South Pars project will be completed during the first half of the next decade, the new phases providing about 143 bcm of gas annually. By 2030, total gas production may rise to 250 bcm/y, but reinjections might reach 90 bcm/y.72 Thus about 160 bcm/y are left for both domestic consumption and export (in 2013, total gas production was 164 bcm). This point is important; Iran was unable to reach its production and export targets even before the last round of harsh economic sanctions.
The high domestic consumption still hinders Iran's gas exports to the EU. After 2012, when the EU declared an embargo on oil and gas imports, Iran's annual GDP growth rate collapsed, along with the country's industrial production. At the same time, its gas consumption plateaued. Hence, after economic sanctions are lifted, we can expect a rapid rise in domestic consumption as the economy recovers and oil production is increased.73 In the most optimistic scenario, the overall gas exports cannot reach 30 bcm/y until 2025 at the earliest.74
Until 2012, when the EU imposed an embargo on oil imports, Iran was its sixth-largest supplier of petroleum. Due to its high domestic gas consumption, however, Iran has not yet started to export any to the EU. In spite of this, Iran is actively promoting its gas-export plans to Europe as well as to its neighbors. In 2008, Iran proposed the Persian Gas Pipeline, which, according to Tehran, would supply 25-30 bcm/y to Europe from South Pars via Turkey.75 Yet as the preceding section showed, this volume will be available only in 2025 at the earliest. Otherwise, exports will come at the expense of domestic consumption, which is politically unacceptable.
Iranian gas thus cannot be considered an alternative to Russian gas. Nevertheless, if the EU sets a more modest goal, Iran can play a role in the European energy-security strategy. The EU could try to replicate the 2009 situation, when the influx of cheap gas offered an opportunity for the EC to push gas market integration at Gazprom's expense. According to ERIRAS, "the break-even price for Iran's new fields is below $50 per thousand cubic meters, which […] makes gas from [Iranian] projects highly competitive."76 An inflow of cheap Iranian gas could lead to a 10 percent decrease in spot market prices in Europe.77 Furthermore, the rise of liquidity on the EU market supplied by Iranian gas might force Gazprom to further amend its long-term contracts, as occurred between 2009 and 2012.78
Thus, the EC might use cheap Iranian gas as leverage against Gazprom and further diminish its dominant position in the European gas market, if not through a significant cut in its market share, then through a softening of its regulatory power — its long-term contracts. Nonetheless, even this goal requires direct foreign investment in the Iranian energy sector. As Vakshhouri estimates, Iran's oil and gas sector will need investment of about $200-250 billion upstream, midstream and downstream over the next five years.79 Meanwhile, France, Germany, Italy, Spain and other European countries have already expressed their interest in entering Iran.
Investment upstream can improve the Iranian recovery potential for both oil and gas, especially in the case of the South Pars gas field, but the level of foreign engagement will depend on reform of the buy-back contracts.80 It will take some time, however, before the Majlis votes the new draft into law. The Guardian Council has already expressed its disapproval of buy-back contracts, arguing that they contradict Islamic law. This decision was later overruled by the Expediency Council,81 but this time, the bill will contain an even more radical version of the contracts.
In the case of downstream, assistance with the energy-efficiency programs provided by the EU or its member states, as well as IOC investment in renewables, power generation and so forth, would help Iran decrease the energy intensity of its economy. This is particularly important, since gas accounts for a 70 percent share in power generation, while the power plants' efficiency rate is only 37 percent.82 Furthermore, improvement in transmission capacities, currently involving large losses, will release some gas for export. Overall, the energy efficiency program will require investment of $192 billion.83 However, investment from abroad can only be secured if there is significant subsidy reform, a politically sensitive issue. Here, Iran and the EU can restore the "Comprehensive Dialogue," launched in 1998 but, due to disagreements over the Iranian nuclear program, suspended in 2002.84 This dialogue included the joint Working Group for Energy and Transport, which also focused on issues related to efficiency.85
Yet for Iran, Europe is only one of several potential markets. During the last decade, Iran has tried to negotiate supply contracts with countries in the region, including Oman, the United Arab Emirates, Bahrain, Syria, Pakistan and India.86 All these attempts failed. In 2014, however, Iran started negotiations with Oman and India for an underwater pipeline with a capacity of about 11 bcm/y.87 In all the previous negotiations, the maximum volume that Iran proposed for its gas exports, with the exception of the Persian Gas Pipeline, never exceeded 10-11 bcm/y. This is probably the maximum volume that Iranian officials are expected to release for export in the near future, while the Persian Gas Pipeline, with a capacity of 25-30 bcm/y, could well be a public relations move to attract foreign investors. It seems more plausible that Iran plans to build IGAT-9, which would have a capacity of 25-30 bcm/y and stretch from South Pars to its northern regions. Part of the gas would be consumed there, and the remaining 10 bcm/y transmitted through interconnectors to Europe via the Turkish Trans-Anatolian Pipeline (TANAP). The recent announcement that a separate pipeline to Europe is not economically viable under current low prices indicates the likeliness of this way of thinking.88
Another option for Iran is to focus on LNG projects. Exports of LNG can provide flexibility in case a crisis between the EU and Tehran emerges. Before the sanctions were imposed, Iran worked with Germany's Linde AG to build an LNG gas plant with a capacity of 10.8 million tonnes/year or almost 15 bcm/y. Although Iran has already invested $2.5 billion in this project, sanctions forced Linde to abandon it. However, even if cooperation on the LNG terminals is resumed, it will take six to eight years to finish construction.89 Moreover, land-based terminals are expensive and often require long-term contracts to secure a return on investment.90
The long-term contracts, however, run against the EC's interests. An alternative is for Iran to supply gas via an underwater pipeline to Abu Dhabi's LNG plant at Das Island (which otherwise will run out of fuel by 2019) and then send liquefied gas to Europe. The price is still too high, however. In summer 2015, information was leaked that Iran is in talks with "some unnamed company" for the purpose of renting a floating LNG vessel, less expensive than a land-based terminal. This unnamed company was probably Royal Dutch Shell, which operates such facilities and owes about $2 billion worth of debt to Iran — not repaid due to sanctions.91 Accordingly, Shell may partly offset this debt by providing the floating facility and participating in the development of South Pars. Yet, without long-term contracts, there is no guarantee that Iran will ship LNG to Europe. On the other hand, there is probably hope in Europe that the expected worldwide rise in the LNG supply will push prices down, whatever the source of the gas is.92
Iran might well focus on exports to neighboring countries, whose demand for gas and electricity is soaring. It has already built its part of the pipeline to Pakistan, while Islamabad, due to sanctions, has been delaying construction on its territory.93 After the nuclear deal, the problem might be resolved. Pakistan is an energy-deficit country; thus, Iran can safely secure its market share there, while in Europe it will have to compete with Gazprom.94
Another problem between Iran and the EU is the unresolved question of sanctions. On January 16, 2016, the EU lifted all nuclear-related sanctions when the International Atomic Energy Agency (IAEA) confirmed that Tehran had fulfilled its obligations as set out in the JCPOA.95 But the nuclear deal has a "snapback provision:" for a period of up to eight years, sanctions can be re-imposed if Iran violates the agreement.96 This will make Western investors cautious about doing business in Iran.97
For its part, Tehran might well pursue its gas-export strategy of binding Iran and the EU together in order to make member states more reluctant to re-impose sanctions in case of a disagreement over whether Iran is faithfully implementing the JCPOA. Hence, from a strategic perspective, building strong ties with Western energy companies, making the new buy-back contracts extremely attractive for the IOCs, boosting its exports to the EU and forging economic ties with member states are necessary measures for Iran's freedom of maneuver within the stringent JCPOA.
There are two downsides of this strategy, however. First, it is purely speculative, and the behavior of the EU and the United States is beyond Iranian influence. Moreover, the significant volume of oil imported from Iran before 2012 did not prevent the EU from sanctioning the Iranian energy industry. Another problem relates to the entrenched interests of the Iranian Revolutionary Guard Corps (IRGC). Its affiliated companies have gradually gained a significant stake in the Iranian economy, especially the energy industry. The IRGC is also believed to be a major proponent of the nuclear program,98 and they will probably try to compensate for their loss in the energy industry. In September 2015, NIOC denied the French company Total the development of Phase 11 of South Pars, despite an earlier meeting with Zanganeh in which French Foreign Minister Laurent Fabius tried to secure French interests in the Iranian energy sector.99
Thus, it might be in the Iranian interest to focus rather on Asian markets, including China and India,100 especially when China is building alternative financial institutions such as the New Development Bank and a Chinese version of SWIFT.101 China has already expressed its willingness to finance the gas pipeline to Pakistan and plans to increase bilateral trade with Iran in the next 10 years to $200 billion per year from the current $50 billion.102 In contrast, today the value of trade between Iran and the EU is about $6 billion.103 It is also possible that Iran, Russia and other "like-minded" states together with China and the rest of the BRICS will jointly cooperate on a number of economic ventures, including energy projects, in order to become less dependent on Western investment, technology and financial institutions. This will make them immune to Western sanctions. The last proposal on oil and gas swap deals, raised during the meeting between Russian Minister of Energy Alexander Novak and his Iranian counterpart, Zanganeh, might fit into this scenario.104
The problem of the EU's energy dependency on Russia has two elements. The first relates to the physical volume of gas Russia supplies through the pipeline network. With the two energy crises in 2006 and 2009, along with the general worsening of the Russia-EU relations, this dependence is perceived as problematic from the perspective of supply security. Secondly, Gazprom and the European Commission promote different views of the European gas market. Gazprom wants to keep its near monopoly and set the conditions of trade in long-term contracts. The Commission, on the other hand, wants to establish a liberalized competitive spot market regulated by EC guidelines. In order to achieve this goal, the EU needs to secure alternative supplies of cheap gas. After the successful resolution of the Iranian nuclear program, Iran, with its vast gas resources, is often named as a potential alternative supplier.
An analysis of the Iranian energy industry shows, however, that exports of substantive volumes of natural gas to the EU (around 30bcm/y) cannot be expected before 2025. Iran's gas export potential is limited by the large domestic gas consumption, gas reinjections into the maturing oil fields, poor management of the energy industry and the difficulty of attracting foreign investments into the upstream sector. These are the long-term problems that existed even before the last two rounds of sanctions in 2010 and 2012. Therefore, if Iran is to attract foreign investments, it is not sufficient to lift the economic sanctions, as Iran must implement a politically sensitive reform of its energy sector.
First of all, it is necessary to reform the buy-back contracts to make them more attractive for IOCs, which can provide the needed technology for oil and gas production. Second, Iran must move forward with a subsidy reform program that is necessary to improve the energy efficiency of the economy. Third, depolitization of the energy industry and improvement of the NIOC management are two other import tasks for the Iranian government. It is not clear, however, if President Rouhani will have the power to scale down the IRGC's grip over the energy sector. But if the reforms are successfully implemented, European companies might be willing to invest not only in the upstream sector, but also into downstream and provide technology for the improvement of energy efficiency and for the use of renewables. The EU, on a bilateral basis, can help Iran on this front.
Yet in the near term, since Iran plans to increase its oil production and exports, the priority will probably be put on the gas reinjections. It is unlikely, therefore, that Iran will be able to export more than approximately 10 bcm/y of natural gas. If, however, the European goal is not to diminish gas exports from Russia as such, but to change the structure of the gas market, the EU can even use limited volumes of gas from Iran, though preferably in combination with some other sources, to fill the European spot markets with a cheap gas in order to decrease the gas prices relative to Gazprom's long-term contract prices. This will further pressure Gazprom to make some concessions and amend its contract formulae, as was already the case in 2009. Iran, from its perspective, can use gas deliveries to Europe as a hedge against the snap-back provision, and this hedge might provide Iran with space for maneuver in the framework of the JCPOA. Yet Iran's oil exports to the EU did not prevent the sanctions against Iran. Thus Tehran might prefer to engage with non-Western nations such as China, India or Russia in regard to its oil and gas exports. The new alternative financial institutions promoted by China can diminish the Iranian vulnerability to the Western sanctions. To prevent this scenario, the EU must clarify the conditions under which it might "snap back" its sanctions. Similarly, any future cooperation between NIOC and IOCs should also be accompanied by political support from the side of the EU.
In sum, Iran cannot limit European dependency on Russian gas on its own. Though the EU can use Iranian gas supplies as a means to pressure Gazprom to change its contract terms, the poor state of the Iranian energy sector and the political uncertainty involved hinder any attempts to use Iran as an alternative supplier.
1 Stephen G. Carter, "Iran, Natural Gas and Asia's Energy Needs: A Spoiler for Sanctions?" Middle East Policy 21, no. 1 (March 11, 2014): 41-61, doi:10.1111/mepo.12056.
2 "Iran Offers Europe 'Big Volumes' As Russia Threatens to Cut Supply," Oil & Gas Post, May 6, 2014, http://www.oilgaspost.com/2014/05/06/iran-offers-europe-big-volumes-rus….
3 British Petroleum, "BP Statistical Review of World Energy" (64th edition, June, 2015), http://www.bp.com/content/dam/bp/pdf/energy-economics/statistical-revie….
4Communication from the Commission to the European Parliament and the Council: European Energy Security Strategy. European Commission, May 28, 2014, COM(2014) 330 final, http://ec.europa.eu/energy/en/publications/european-energy-security-str…. Hereafter referred to as European Energy Security Strategy.
5 Commission Staff Working Document: Trends and Developments in European Energy Markets 2014. European Commission, October 13, 2014, SWD(2014) 310 final, http://ec.europa.eu/energy/sites/ener/files/documents/2014_iem_communic…. Hereafter referred to as Commission Staff Working Document.
6 Kirsten Westphal, "Security of Gas Supply," SWP Comments, 2012.
7 James Henderson and Tatiana Mitrova, The Political and Commercial Dynamics of Russia's Gas Export Strategy, NG 102 (Oxford: Oxford Institute for Energy Studies, 2015); and Zeyno Baran, "EU Energy Security: Time to End Russian Leverage," Washington Quarterly 30, no. 4 (September 5, 2007): 131-44, doi:10.1162/wash.2007.30.4.131.
8 Mert Bilgin, "Geopolitics of European Natural Gas Demand: Supplies from Russia, Caspian and the Middle East," Energy Policy 37, no. 11 (2009): 4482-92, doi:10.1016/j.enpol.2009.05.070.
9European Energy Security Strategy, 2.
10European Energy Security Strategy, 12.
11 Consolidated Version of the Treaty on the Functioning of the European Union art. 194(1), 2008 O.J. C 115/47.
12Commission Staff Working Document.
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