THE ROLE OF ITALY IN THE IRANIAN ENERGY SECTOR
By: Farian
Sabahi, Post-doctoral Fellow, Faculty of Economics, Bologna
University, and free-lance journalist specialised on the Middle East for the
Italian daily economic and political newspaper Il Sole 24 Ore and for Radio
Svizzera Italiana.
D. Knott, "Buyback Contracts Changes Dominate Iran Oil Conference" in MEES,
13/11/2000, A5.
Paper by B.M. Rahmani presented on 4/11/2000, quoted in MEES, 13/11/2000,
A5.
MEES, 05/03/2001, A9; 19/2/2001, A12-A13;27/11/2000, A12; 13/11/2000,
A5-A8.
__________________________________________________
In the Islamic Republic of Iran, the regime's interest is more important than
Islamic law (dar johmur-e eslamie maslahat-e nezam az shariat mohemtar ast)
and oil contracts provide a good example. Recent events in Iran make clear
that the clerical elite is operating on a knife-edge: one side involves Tehran's
ability to develop business relations with European partners that have largely
blunted the effect of US sanctions. The other side of the knife-edge concerns
the response of factions within Iran to increasing international business
relations.
These business relations are mainly about oil. International operators undertake
oil and gas field development projects in the form of buyback contract , where
developers are paid in oil. More in detail, under buyback contracts signed to
date, international companies act in a similar way to engineering contractors.
When production is started, they are required to hand over operatorship of the
new fields, or enhance recovery schemes they have developed, to the National
Iranian Oil Company (NIOC).
Buyback have recently been a hot issue. Terms of such contracts were discussed
in the Iran Oil Conference organised on 4-5 November 2000 by Iran's
Institute for International Energy Studies in Tehran. Criticism of Iran's
buybacks came in a paper presented by Bijan Mossavar Rahmani, chairman of
Mondoil Corporation. According to him, buyback had "only a limited success
so far because these contract are not the risk-reward formula of choice, either
for Iran or for the oil companies".
At the same time (November 2000), the reformist-dominated and increasingly
nationalist Iranian parliament (Majlis) expressed concern over the role
played by foreign companies in the oil sector. It insisted on debating the
validity of buyback contract terms for new projects in order to align the
Iranian economy with global markets. In February 2001 parliamentary obstacles
were removed: the Expediency Council, Iran's highest legislative court of
appeal, overruled the decision taken by the conservative Council of Guardian
that buyback contracts supported a form of interest forbidden in Islam, and
stated instead that buybacks were lawful.
Oil is the main source of revenue for the Islamic Republic and defines Iran's
political struggle. On the international scene, the attractiveness of oil as a
resource has led Europe to co-operate with the Islamic Republic and thus
dismantles US sanctions. On the domestic Iranian scene, buybacks have been used
as one of the many weapons in the fight between conservatives and reformists,
and have raised criticism from within because, according to strict
interpretations, buybacks do not respond to Islamic law.
Iran has the world's fifth largest proven crude oil reserves (about 90bn
barrels) and the second largest natural gas proven reserves (some 23 trillion
cube metres). Daily oil production is 3.89 million barrels. In 2001 the
government was planning to expand production, but in March OPEC approved a cut
of one million barrels per day (b/d) in its output, the second large reduction
in few months. The OPEC move is intended to stabilise prices and will oblige the
Islamic Republic to hold back its production growth this year to 3.7 million
b/d. As a result, there will be no repeat of the estimated 9.5% increase in
production generated over 2000-2001.
In the last few months new oil fields have been found. In February, NIOC has
announced a giant off-shore oil discovery in the Gulf, near Abadan, possibly as
large as the recent Azadegan discovery (estimated 26bn barrels and recoverable
reserves of 5-6bn barrels). These new fields have been advertised on the Iranian
television as part of an attempt to rebuild the nation's morale which suffered
in the face of high unemployment rate.
At this stage, Iran needs to develop new oil and gas discoveries and to sustain
production of its fast ageing matured oil fields. One of Iran's problems is the
increase in domestic energy consumption. In fact, between 1980 and 1999
consumption of refined products has more than doubled. The staggering
consumption growth was caused by the following factors: the increased revenue
from crude oil exports created wealth, allowed subsidisation of energy prices
and fuelled household consumption and inefficient use; quadruplicating of the
national population, from over 16 million in 1951 to 65 million in 1999;
urbanisation.
Iran needs to decrease production costs and improve management efficiency
through the acquisition from abroad of advanced technologies and know-how, which
are behind those of other competitors such as Saudi Arabia. Since the regime is
unable to carry the whole investment burden with domestic capital, it needs to
attract foreign firms.
In order to double Iran's oil production capacity over the next 20 years and
exploit its gas reserves, Tehran expects to invite $20-50bn in foreign capital.
In this context, international investors will mainly operate in the up-stream.
However, before entering the Iranian market foreign firms ask legal protection
against nationalisation and guaranteed rights to repatriate capital and profits
in hard currency.
Besides the failings of the legal framework and constitutional restrictions on
foreign capital, international companies investing in Iran must cope with two
other major problems. First, the contract term for buy-backs is perceived as too
short: the investment recovery period is of around five years, while a project
period is generally of around 7-10 years. Second, investment returns may be
smaller than expected due to cost overruns which are borne by investors.
Another important factor to be taken into consideration in an analysis of the
Iranian oil sector is the relationship between Iran and the US. Due to sanctions
imposed by Washington that penalise companies investing more than $20 million in
Iran, US companies are currently unable to invest in Iran. Though fearing
reprisals from the Treasury's Office of Foreign Assets Control (OFAC) and thus
scrupulous in their adherence to the law, US companies are more and more vocal
in their opposition to sanctions against Iran.
In the context of US sanctions, in 1995 the US operator Conoco lost the
development of the project Sirri A and E fields, which eventually landed in the
hands of French Total. And Chevron recently had to make clear that it did not
intend to make an offer for the South Pars Phases 9-12. Needless to say,
American companies are paying dearly for US policy.
On 14 March a Foreign Ministry official was quoted as saying: "The American
government should learn from its failed policies and give up behaviour contrary
to international regulations. American companies are the ones losing the most
from such sanctions". Furthermore, Robert Pelletreau, former US Assistant
Secretary of State for Near Eastern Affairs, noted: "There is no doubt that
the US and Iran can live without each other. They have been doing so for more
that two decades but, I would submit, both nations are the poorer for it. This
is not the relationship either side's leaders would like to see if they could
design it from scratch".
Washington is implementing two policies against Iran. As already mentioned, the
first policy (sanctions) has been dismantled by the readiness of European firms
to co-operate with Iran. The other policy is more effective: the US strongly
oppose the passage of pipelines and propose the construction of a $3bn pipeline
from Kazakhstan to Baku (Azerbaijan) to the terminal of Ceyhan on the
Mediterranean shore of Turkey. Ankara is one of the American allies in the
region and, as widely reported by international media, is craving for cash in
order to overcome its financial crisis and pay back IMF loans.
The passage of oil through pipelines is a source of royalties income while the
passage through the Bosphorus is free. On various pipeline routes transportation
costs per barrel differ: the Baku-Ceyhan option costs $2.2 while the option from
Neka (Iran's port on the Caspian Sea) to the Persian Gulf is evaluated between
$1.2 and $2.0. Needless to say, Iran's strategic position at the crossroad
between the Middle East, the Caspian basin and Central Asia makes it one of the
most efficient road for pipelines.
According to Christophe de Magerie, TotalFinaElf's Vice-President for
Exploration and Production, "among the (oil export) alternatives available
today, two are more serious than others, namely the route to the north (via the
Russian Black Sea port of Novorossiysk) and the route through Turkmenistan to
Iran". And, he added, TotalFinaElf's choice would be through Iran.
If the relation between Tehran and Washington were not so strained, the US would
probably opt for the passage of oil through Iran. In a recent interview the
Iranian foreign minister Kamal Kharrazi declared that there are "chances
that there may be a change of policy by the new US administration" towards
Iran, but cautioned that "it is too soon to judge".
In reality, besides pipelines running through Iran, the most efficient option
for the Islamic Republic is currently the swap of oil with neighbours in the
north. This is the system whereby exports from ex-Soviet Republics to Iran would
be compensated with the equivalent volumes from the Persian Gulf. This is a
convenient option for Iran because the large majority of its population is
concentrated in urban areas in the north of the country. The need for energy is
thus focused in the north, while the richest oil fields are in the south, along
the Persian Gulf.
The cost of oil swap arrangements between Iran and the Caspian Sea are estimated
to be only $2 per barrel and thus represent a cost effective solution to the
transportation problem. So far, crude swaps have been arranged with Kazakhstan:
oil was shipped to Iran's port of Neka on the Caspian Sea for delivery to the
Tehran refinery, in exchange for equivalent quantities of Iranian crude for
loading at Kharg Island (in the Persian Gulf). However, the arrangement was
stopped due to the high mercaptan content of the Kazakh crude. According to
Tehran, Iranian oil refineries need serious refurbishment to be able to process
the Kazakh grades.
At the same time, swaps via Iran have been undertaken from Turkmenistan. The
pipeline has a capacity of 40.000 b/d, which has been upgraded to 100.000 b/d.
As swap business expands, a project is under study for a 350.000 b/d pipeline.
In fact, the Kazakh president Nursultan Nazarbayev has asked France's
TotalFinaElf and Italy's Agip to consider a transportation project outside the
Baku-Ceyhan scheme.
***
Despite US sanctions against Tehran, renewed by US president George W. Bush
on 13 March, many countries showed an interest in Iranian oil. The 14th annual
survey for clients carried out by exploration consultants Robertson
International of Llandudno, UK, rated Iran second most attractive country to
international oil companies for new ventures activities, just behind Libya and
before Algeria.
Europe is eating America's slice of the Iran oil cake. Between the end of
February and the beginning of March, Iranian leaders received Italian Prime
Minister Giuliano Amato, British Minister for the Cabinet Office Marjorie Mowlan
- the most important British diplomatic mission to Iran since the Revolution of
1979 - and other high-ranking officials from Cuba, Ukraine, Austria, Cyprus,
Turkey, Poland and Bahrain. But also other countries are involved: since poor in
energy resources, Japan has developed a precise policy towards Iran and signed
contracts.
Among others, Italy has so far enjoyed a privileged position. While Germany
remains Iran's biggest supplier, in 2000 Italy increased its lead as the EU's
top trading partner with Tehran with sales totalling 3.3bn Euro, boosted by a
late increase of 25% in Italian exports to 842m Euro. Furthermore, in 2000
Italian imports of crude Iranian oil rose 11.7%.
Italy's pole position is due partly to historical ties and partly to the
political relationship developed in recent years. Rome has an expertise in
difficult mission and a long tradition in opening up self-isolated countries. In
March 1998 Italian foreign minister Lamberto Dini visited Iran, followed three
months later by Prime Minister Romano Prodi, and thus opening the doors of the
Islamic Republic. In March 1999 Iranian president Muhammad Khatami made an
official trip to Rome, his first to a Western country since he had been elected
in May 1997.
On 16 January 2001 the Italian foreign minister Lamberto Dini met in Rome his
Iranian counterpart Kamal Kharrazi. They defined the relationship between the
two countries as "excellent", not only on business terms but also from
the political and cultural point of view. Dini explained that Italy played a
major role in contributing a new country risk-rating for Iran. He also suggested
the possibility of allowing the immigration of Iranian workers.
On 8 February 2001 the president of National Petrochemical Company (NPC) and
vice-minister for oil Muhammad Reza Nematzadeh attended a seminar in Milan
organised by NPC, Federchimica and Istituto per il Commercio Estero (ICE) on
potentials and perspectives of the petrochemical Iranian industry. Stated the
high potential of this sector, it was pointed out that the SACE (Italian
insurance agency for exports) provision for investments in Iran is currently
insufficient.
In an interview, Nematzadeh declared that since 1997 two phases have been
realised in the development project aiming at bringing the Iranian petrochemical
industry from a production capacity of 15 million tons to 40 million tons. The
third phase has just started and is supposed to finish by the end of 2005. This
development is focused on down-stream activities and can rely on a domestic
consumers market of 65 million persons. The total cost is $10bn. The main
investment will be paid by NPC, while 20% will be covered by joint-ventures with
foreign firms, among which Italian companies enjoy a privileged role.
According to Guido Venturini, director of Federchimica, Italian firms play a
significant role in Iran due to three factors. First, since Italy needs basic
chemical products, with the development of the chemical industry Tehran has the
potential to become an important partner for Rome. Secondly, local markets offer
interesting opportunities and, thirdly, Italy enjoys good diplomatic relations
with the Islamic Republic.
***
The other side of the knife-edge, on which the Iranian clerical elite is
operating, concerns the reaction of factions in Iran to increasing business
relations between Iran and Europe. At the end of February Italian Prime Minister
Giuliano Amato and Minister of Industry Enrico Letta travelled to Tehran. Their
trip has a particular significance since it happened in a very delicate period.
In fact, in the last year the conservative clerical elite leaded by the Supreme
Guide Ali Khamenei - and controlling the Council of Guardians, the Expediency
Council, the Revolutionary Guards, the judiciary, the army and the security
apparatus - has closed around thirty newspapers and thrown in jail tens of
journalists and intellectuals. Amongst others, the revolutionary court has
questioned Ahmad Bourghani, high official in the Ministry of Culture and Islamic
Guidance, who is also president of the Iran-Italy Friendship Association.
As a consequence of the violation of human rights - as perceived by the Italian
media and MPs - Amato and Letta were asked not to travel to the Islamic
Republic. As a compromise with domestic political forces and the business
community, they did go Iran but kept their visit very short: "A mission due
to last a couple of days was 'burnt' in a few hours. Nonetheless, time was
enough for Giuliano Amato and Iranian president Muhammad Khatami to talk about
democracy, human rights and business". Once more, Italian politicians
provided a good example of Realpolitik.
***
Besides the presence of small and medium enterprises doing business with
Iranian counterparts, the Italian economic presence is linked to petrochemicals.
For instance, together with LG Engineering of South Korea, Italy's Snamprogetti
has just been awarded contracts to engineer and build a carbon monoxide plant
and an acetic plant in the Bandar Khomeini special zone. For licensing,
engineering, material and equipment, and technical assistance, Snamprogetti will
receive $40 million for a 22 months project to be realised in partnership with
the local Sazeh Consultants. And recently Italy's Saipem has proposed to Iran
and India the construction of a direct gas pipeline which would supposedly save
at least $2.000 million compared with rival transport proposals.
Among Italian actors, ENI plays the main role. Until 1995 a state-owned domestic
monopoly in gas, ENI was first floated in November 1995. As part of its
privatisation programme, the Italian Ministry of Treasury is expected to divest
its remaining 30.4% stake in ENI. According to The Times, Italian ENI is
now "bristling with sexy performance targets for production growth and deep
cost cuts to pump out superior profits by 2003" and "given that last
year's total operating profit and net profit doubled to 10.77 billion and 5.77
billion respectively, and sales soared 55% to 47.9 billion, ENI has gained
credibility as a profitable player in the Big Oil league".
ENI's strategy can be summed up by its CEO Vittorio Mincato: "Big mergers
have not changed the basic problems of the oil industry". In fact, instead
of merging as other oil majors did, ENI preferred to proceed to the acquisition
of British Borneo and Lasmo, still keeping its weight amongst oil giants. ENI
kept its own identity and focused on investments.
In which countries does ENI operate? Its interests go far beyond the Italian
market and the Mediterranean basin. The Italian up-stream market is mature and
its down-stream is becoming more and more narrow. According to analysts, the
number of pump stations will decrease and their annual sales will then move from
1.5 to 2.5 million litres. At the same time, their number should increase in
South America (Brazil) and in Italy's neighbours such as France, Switzerland,
the south of Germany and Austria.
In the last few years the Italian market accounted for 60% of ENI's profits and
other markets for the remaining 40%. In the near future ENI is planning to rely
on foreign markets for 70% of profits. ENI's new frontiers go as far as Central
Asia, Indonesia, the North Sea, the Mexican Gulf and Western Africa. In this
framework, Iran can represent 6-8% of ENI reserves, just behind Libya, also due
to the agreement of July 2000 with NIOC for the development of the fourth and
fifth phases of the South Pars field in the Persian Gulf.
According to Mincato, ENI's presence in Iran is "the result of a silent,
constant and articulated action". In fact, ENI left Iran in 1979. US
sanctions imposed a drawback of American companies. At that stage AGIP, which is
owned by ENI, signed the first agreements for the Doroud fields, the huge gas
field in South Pars in the Persian Gulf (July 2000) and the recent contract for
Balal. Shortly, ENI will have in Iran buybacks for 400 million barrels.
***
Foreign countries do not only provide direct investments to the Islamic
Republic. In fact, according to the Iranian Deputy Minister of Energy Muhammad
Reza Na'amat, who also serves as Managing Director of the Iranian National
Petrochemicals Corporation (NPC), the governments of Italy, Germany and France
granted Iran loans totalling $550 million in order to develop the petrochemicals
industry, with a focus on vocational training for staff. Furthermore, in
February 2001 Italy's Banca Nazionale del Lavoro has signed with Iran's Bank
Markazi Jomhuri a $100 million credit line covered by SACE (Italian insurance
agency for exports) in order to finance 85% of exports contracts towards Iran
involving small and medium Italian enterprises.
Which are the consequences of the energy sector on domestic Iranian politics?
Since the price of the barrel has an enormous influence on the budget of the
government, oil has a huge impact on the implementation of domestic policies and
politics. The arrival of Khatami to power in August 1997 coincided with a sharp
decline in the price of oil which reached $10 per barrel. Such a low price
brought to an halt a number of developmental and productive projects, and
disrupted short-term plans to create new employment opportunities. On top of
that, Khatami had to cope with a severe drought and with payment of foreign
short-term debts left by the Rafsanjani government.
More in detail, which are the political consequences of international support
for the reformist front? A conservative paper has questioned Western support for
reformists and made explicit reference to Italy: "All the statements and
announcements issued within the last two years by the EU, the European
Parliament, Western parliaments and foreign governments have condemned the human
rights situation in Iran and have openly supported reforms and reformists. The
latest example was the visit to Tehran by the Italian Prime Minister, who
supported the reformists in Iran".
At the same time, an editorial published on the Iranian conservative weekly Shoma
has strongly criticised president Muhammad Khatami for his openness towards some
European countries and also for having been compared to Russian ex-president
Gorbaciov: "Your Excellency Mr Khatami, do you like to be a president
supported by Germany and Italy? Should we not be ashamed of being supported by
foreigners? Do you really like to see that the faction you have chosen to run
your government is being praised and protected by foreign media? It is the West
which needs our $63bn market and our strategic position!"
As mentioned at the beginning of this paper, oil defines Iran's political
struggle. However, political uncertainty and pressure from different factions do
represent a risk. In fact, Iran is rich in reserves but its energy sector is
characterised by ageing oil fields in great need of technology which cannot be
provided by local companies.
Which consequences will have the presidential elections of 8 June on the oil
sector? Taking into account the presence of two main factions - the reformists
headed by Khatami and the conservatives (also called by the media
"religious right") represented by the Supreme Guide Ali Khamenei - it
should be remembered that all those who will be allowed to run for elections
will somehow belong to the establishment. In fact, candidates are to be approved
by the Council of Guardians.
Khatami has yet to confirm if he will stand for re-election, but his opponents
recognise "the damage the loss of Mr Khatami would cause to the Islamic
republic's domestic legitimacy and external credibility". Khatami
withdrawal from the political scene might lead to the emergence of a more
radical reform movement unwilling to "compromise with the clerical elite
and ready to take its demands for a compete overhaul of the political system
onto the streets".
At any rate, one cannot fail to observe two facts. First, though president
Muhammad Khatami spent ten years in Hamburg as imam of the local Shia mosque on
a diplomatic passport of the Iranian monarchy, he is an offspring of the Islamic
Revolution of 1979. He does have a more attractive appeal for the Iranian youth
and foreigners and, though "the clothes don't make the man", he still
wears the mullah's garb.
However, in three and half year of office Khatami never dared to make a strong
speech against the continuous jailing of journalists and intellectuals. In the
best case, he expressed "regret". It is true, Khatami has not enjoyed
Khamenei's favours as much as his predecessor Rafsanjani: the reformist
president has not regularly been in charge of the Friday prayer and he was
allowed only short appearances on the Iranian National Television controlled by
conservatives.
Second, in twenty-three years a new elite emerged. The new ulema got more and
more involved in politics and, in order to enrich themselves and preserve their
power, have developed an interest for economic activities. They now play a major
role in the bonyad (foundations, or Islamic 'charitable' conglomerates)
lying in a grey area between public and private sector, owning 80% of the
country's assets and producing less than 20% of its GNP.
In conclusion, three last considerations should be taken into account. First,
oil is and will remain the main resource of the Islamic Republic. This reality
contrasts with the discourses of the clerical elite at the beginning of the
Revolution, when they strongly condemned dependence on oil exports as a negative
policy conducted by the shah. Second, the elite in power has no interest in
missing the opportunity to further enrich themselves and increase their power
through the distribution of wealth to their affiliates.
Third, the Iran-Iraq war (1980-1988) caused severe damages to Iranian
refineries. As a consequence, some petrochemical products - such as gasoline for
aviation - have to be imported. Given the lack of adequate technology and the
weakness of the Iranian private sector, in the years to come the Islamic
Republic will annually need $10bn foreign investments in order to keep up with
the development of its energy sector, especially as regards gas. Under present
circumstances, buybacks allow foreign firms to receive oil for investments,
without getting into trouble with the constitution forbidding mineral
concessions to foreigners.
12 April 2001