by Dimitri Papamichaïl
In July 2015, negotiators from the P5+1 group (five permanent members of the UN Security Council plus Germany) reached a deal with Iran, in which Iran would halt its nuclear research in exchange for the lifting the economic sanctions. At the margin of P5+1 negotiations (five permanent members of the UN Security Council plus Germany dealing with the Iranian nuclear issue), it has been recurrently mentioned that natural gas from Iran could become an alternative to Russian gas for Europe. This might have been an additional argument in favor of a deal, permitting to release investments towards the Islamic Republic of Iran and its gas sector in particular. Indeed the 33,6 trillion cubic meters of natural gas that make Iran the world’s second largest reservoir of the intangible fuel, may stimulate the pipeline fantasies of some Eurocrates, as well as the appetite of many businessmen in the old continent. Since the start of the Ukrainian crisis, the reliability of European gas imports is considered to be at threat once again, especially in Eastern and South-Eastern Europe. These areas rely, sometimes exclusively, on the Bratsvo and Soyuz pipelines for their imports of gas (Figure 1). The initiation of the Trans-Anatolian Pipeline’s (TANAP) construction, that coincided with the deal on Iranian nuclear program, have brought a wind of hope regarding the possibility for Iranian gas to join this project.
It is often proposed that any major gas pipeline link between Europe and Iran increases the former’s arbitrage capacities and creates competition for the 135 bcm of Russian gas annually imported by the European states. What are the realistic perspectives of such major project in light of Iran’s domestic gas sector management and rationale for exports? What is the possible impact of bilateral relations with Russia in Iran’s choices in relation to gas exports to Europe?
Iran as a potential nodal supplier
Iran as an exporter is interested to diversify its export destinations in order to secure demand for its gas and reduce the risks. Besides these strategic considerations, macroeconomic indicators also become crucial when it comes to prioritising projects. In that respect, Europe as the target market for Iranian gas does not have the competitive advantage against other target markets even if the sanctions against Iran are lifted. The European market is remote thus requiring higher expenditures on delivery infrastructure, relatively well served and stagnating. Moreover, the prices in Europe are generally lower than in Asia and acknowledged as a source of concern by Mohsen Qasmari, head of International Affairs at the National Iranian Oil Company.
Iran’s export options could be categorised into the following groups: liquefaction projects in the Gulf; pipeline projects to the Arabian Gulf states; Iran-Pakistan-India (IPI) pipeline; further development of existing connections to Turkey and the Caucasian states.
The Iranian government’s priority has been to develop LNG export facilities. The rationale for choosing this expensive option over others is rooted in the attractiveness of large markets like Japan, South Korea and China, which are also characterised by price levels higher than in other regions. This option was hindered by the UN sanctions, as a result of which several international energy companies had withdrawn from the Iranian gas sector such as, French Total , which was expected to be the leading investor in Iranian LNG projects, but had to step back. In this situation of extremely limited possibility to benefit from the international experience, the implementation of these projects is seriously hindered. Gazprom and CNPC who are dealing with Iran, have limited expertise when it comes to the development of liquefaction terminals. Consequently, the lift of sanctions and subsequent return of Western investors will give a second chance to frozen LNG projects in Iran. Upon completion, these projects might serve as an additional source of gas for the European market.
LNG exports are the only export option that was directly and negatively affected by the withdrawal of Western companies. The sanctions regime did not affect the potential of Iran’s pipeline exports to the Persian Gulf states. In the Gulf, there is strong demand growth for natural gas stemming from the use of the enhanced oil recovery techniques (EOR), as well as increased use of gas for power generation. These factors have created an interesting market space for Iran in the Persian Gulf, even in the conditions of hostility between Iran and the Arab monarchies. A series of Memoranda of Understanding have been signed between Iran and its southern neighbors (except Saudi Arabia) for the construction of several small pipelines up to 10 bcm in each individual case. None of these projects has been realised yet. Most of them have been halted by the disagreement on pricing, but geopolitical arguments can never be excluded in this region. The recent aggravation of the Yemeni conflict, also viewed as a proxy-war between Iran and Saudi Arabia, is negatively affecting the perception of the Islamic Republic of Iran. This means that if the US needed to prevent Iran’s export projects to the Gulf States, it would not be a difficult task. Yet, the commercial dynamics of the market is illustrated by the deal concluded in spring 2015 between Iran and Oman: the parties have agreed upon the construction of an underwater natural gas pipeline supplying 10 bcm of gas annually.
Iran-Pakistan-India pipeline (IPI) is another major project of gas export for the Islamic Republic. This project, which had been discussed since the 1990s, became more realistic in the mid-2000s as relations between India and Pakistan became less tense. The pipeline is expected to feed the Pakistani and Indian markets with 22 bcm of natural gas annually. The first phase of the pipeline is already completed and reaches the Iran-Pakistan border. Deliveries to Pakistan should have started at least from December 2014, however, since the Pakistani section is still not completed. Some experts speculated that the project was halted also due to the US pressure on both Pakistan and India. Even if this is true, a possible lift of the UN sanctions will actually release the obstacles to this pipeline rather than diverting the Iranian gas towards alternative directions. Figure 1 shows that despite the decreasing demand for gas in both India and Pakistan in the past couple of years, the decade-long record is more positive, especially when compared to Europe. Pakistan’s demand grew by 30% (with shrinking domestic production), while the Indian consumption doubled, though reaching no more than 51,4 bcm in 2013 (and thus having huge development potential ahead). 
Finally, when addressing the Iranian gas export choices one should not forget the perspectives for Iran to further develop pipeline exports to Turkey. The 10-bcm Tabriz-Ankara pipeline is Iran’s only real link to foreign markets, along with some minor connections to Armenia and Azerbaijan. The Minister of Oil of Iran has recently proposed to double gas volumes supplied to Turkey, but this proposal was declined. The reason is Iran’s failure as a reliable export partner: several shortages in Iranian Northern provinces have resulted in interruptions of exports to Turkey, and the pipeline has only been used at 60% capacity since its inauguration in 2008. These factors have undermined Turkey’s confidence. Keeping in mind that Turkey itself is developing as a transit hub on the routes to European market, this situation is limiting the potential of Iranian exports to Turkey itself and undermines Iran’s potential as a supplier to the European market.
Overall, it is clear that Iran has huge reserves and a strategically beneficial geographical position. It has options of natural gas exports in various directions, including the Persian Gulf states, South Asia, South Caucasus and Turkey, as well as LNG and the European market. However, having looked at each of the directions in detail, we can conclude that all of them are characterised by a host of problems, both geopolitical and economic in nature. The directions of exports, which may lead Iran to become the European supplier, are the most complicated out of all options, while the lifting of sanctions against Iran will primarily affect its capability to supply less remote markets, e.g. Pakistan and the Persian Gulf.
An outlook of the domestic gas management: Iran as a failed exporter
According to the latest BP Statistical Review, in 2013 Iran consumed 156 bcm of natural gas (which is more than Chinese consumption), and produced slightly more, up to 160 bcm (Figure 2). Iran became a net exporter of natural gas again only in 2012, after being a net importer from 1997 to 2011, with gas volumes coming from Turkmenistan. This surprising performance in terms of production (Iran’s gas reserves surpass those of Russia) is directly related to the political decisions taken by successive administrations, which resulted an increase in natural gas consumption in the total primary energy mix (TPES) from 15% in 1990 to 54% in 2013.
There are strong objections to foreign participation in Iran’s oil and gas sector, especially when it comes from the Western companies. As discussed above, the lack of expertise has already put a strain on Iran’s ability to develop its LNG export industry. However, the cooperation with the Western companies, which have the expertise, needed to develop major projects, is not likely to be actively sought after by the new government. 
Iran has the most heavily subsidised economy of the MENA region: subsidies reach $80 billion and represent one fifth of the GDP. The natural gas sector is no exception. There are subsidies favouring overconsumption, which has resulted in the extremely rapid growth rates of the domestic market since 1990. During the 2000s, Ahmadinejad’s administration was not successful in reforming this sensitive sector: violent protest broke out after the first attempt of reforms in 2007 which implied a progressive increase of gas prices and a switch to market-based pricing. These changes are still pending.
For the failure of capitalising on natural gas exports, Iranians blamed Ahmadinejad more than the sanctions. Rouhani’s ascension in power was expected to drastically change the landscape. Rouhani’s first task was to improve the situation with exports by prioritising projects close to completion, in particular, the IPI pipeline. Notwithstanding the fact that these projects are not bringing any volumes to Europe, exports come only second in the government’s concerns towards the natural gas industry: the satisfaction of domestic demand is far more crucial for the stability of the regime.
Although Rouhani’s administration has effectively taken measures in order to reform domestic pricing and brought some stability in the oil and gas management with the appointment of Bijan Namdar Zangeneh in the Oil Ministry, the new President has not changed the general perception of the investments coming from the West, nor the ineffective institutional framework to which international oil companies (IOC) have to adapt. The historical memory of a humiliating experience when the Anglo-Persian oil company, which had exploited Iran’s national resources, and the anti-liberal ideology of the Islamic regime produced what Jalilvand called a “schizophrenic paradox”: while suspecting foreign companies of acting against the national interests, the Iranian authorities are seeking investments and technology brought by those same companies. The result is a combination of mandatory buy-back contract schemes and a general suspicion of the Iranian authorities towards IOCs that originated investors’ withdrawals even before the 2012 sanctions were imposed.
After the introduction of the sanctions in 2012, with some notable exceptions such as Schlumberger, the main foreign investors in the Iranian gas sector were the Russian companies (in particular Gazprom). In fact, Russian companies are left with a significant advantage in two ways. First, those who decided to stay in the Iranian energy sector expect to be in a better position than their European and American competitors when the sanctions will be lifted and frozen projects start running again. Second, since they are not associated with any colonialist past or imperialist present, Russian companies can also expect to obtain a more favourable attitude from the Iranian authorities. In relation to this last point, and acknowledging that in both Russia and Iran the gas sector is state-managed, one can expect intestate cooperation schemes to emerge. This becomes even more evident when broadening the picture of existing ties between the two countries, which have continued growing recently.
From the “watchful partnership” to the “natural ally”: redefining the ties between Iran and Russia
Experts observe an intensification in bilateral relations since the Islamic Revolution. The period from 1991 to 2011 can be characterised as “watchful partnership” (the Russian diplomacy was reluctant to consider Iran as a “strategic partner”). The situation has drastically changed after the war in Ukraine and the rise of ISIS in Assad’s Syria. In late 2014, Russian Foreign Minister Sergey Lavrov did not hesitate to call Iran a “natural ally”.
From the Iranian side, officials have always been cautious when addressing their perspectives in the European market. Qasmari’s remarks on the unattractiveness of European prices can also be understood as a declaration tending to reassure the Russian partners. As a result of the sanctions imposed on Iran, Russia has increased its presence in the Iranian economy. Two main fields of cooperation include oil supplies and the Iranian nuclear programme.
As expected, last June, a deal between them has been reported, on sales amounting to 500,000 barrels of Iranian oil per day in exchange for agricultural products from Russia. Indeed, as a consequence of the sanctions regime, Iranian oil exports fell from 2,5 million barrels per day in 2010 to less than 1 million barrels per day in 2014, resulting in a GDP contraction of 5% for the first time in 30 years (Figure 3). In fact, Tehran is concerned about its oil exports more than its gas exports, since they constitute a larger share of the national budget. According to recent estimates, oil sales provided 75% of total earnings from hydrocarbon exports. A potential deal with Moscow to sell significant amounts of oil can therefore become a relief for the Iranian government, and has in addition the benefit of guaranteeing food security, which is another main area of concern for the Iranian government.
When it comes to the nuclear sector, the cooperation is even stronger. Rosatom is the contractor for the construction of the controversial Bushehr NPP project. Although the completion of the project has been delayed for more than a decade, subjected to the several undulations in bilateral relations, the power plant was successfully completed in September 2013. In autumn 2014, Russian experts proposed plans for an extension of the present facility and to build new reactors. This explains Russia’s position in favour of Iran in the “P5+1” negotiations.
Military cooperation is another major issue in bilateral relations. Firstly, it is linked to the nuclear problem – since sometimes the delivery of Russian S-300 are associated with the potential to defend nuclear sites against possible attacks. Secondly, the Middle East is in general an important destination for Russian military equipment, and Iran plays an important role for Russia in that respect. Military cooperation between Russia and Iran was revived after Putin’s decision to resume the missile deliveries (previously blocked by Medvedev in 2010).
Other factors that result into convergence of Russian and Iranian positions include:
- Common position on Syria since 2011 and against ISIS since 2014
- Deterioration of Russia’s relations with the West which pushed Moscow to seek new alliances elsewhere
- Importance in having partners particularly in the Middle East, where the Libyan debacle combined with the Syrian civil war had weaken the Russian presence
Obviously, it looks likely that cooperation between two countries will increase in the future. Not surprisingly then, during the eleventh meeting of the joined Russian-Iranian Economic Commission in September 2014, Russia and Iran have agreed to increase the volume of bilateral trade tenfold by 2017, up to $15 billion.
Given the positive environment in which the bilateral relations are evolving, after the 2014 decision to cancel the South Stream project and develop a new route through Turkey to bypass Ukraine, one may even expect volumes of Iranian gas to join Gazprom’s project with minor infrastructure developments within the Turkish territory. Not surprisingly, this solution was publicly considered by Iranian officials. This may also have an advantage for Gazprom of adapting the pipeline to the EU legislation on third party access, with a “third party” willing to cooperate.
Conclusions
In the context of lifting the sanctions, Iran is close to becoming a significant exporter of natural gas. This might lead to the proposition that it will develop into Russia’s key competitor in the European gas market: the bases for such reasoning include Iran’s huge gas reserves (surpassing Russia’s reserves), low marginal costs for major fields, geographic location, and European aspirations to decrease the share of Russian gas in its supply mix. However, such competition is not as realistic as it might seem at first sight.
Firstly, the European gas market is low on Iran’s gas export priorities.
Secondly, the problems in the organisation of Iran’s gas sector may further inhibit the increase of natural gas exports.
Finally, Iran views Russia as an important partner, and cooperation between the two countries ranges from oil sales to nuclear energy and supplies of military equipment. Under these circumstances, it is difficult to imagine the Iranian authorities undermining their only ally in the nuclear talks for any deal providing significant amounts of natural gas to Europe. And if such a deal is not planned today then not only it is unlikely to happen in the near future, but even later developments are compromised since pipeline infrastructure projects are planned several years in advance.
Dimitri Papamichaïl is a graduate of the ENERPO program at the European University at St. Petersburg (academic year 2014-2015). He received his first MA degree in Geography from Pantheon Sorbonne University. Dimitri’s areas of scientific interests include European gas market and competing sources of supply, natural gas hubs, regional focus – South East and South Europe.