The Economy of Iran

General Background

Iran's economy, which relies heavily on oil export revenues, was hit hard by record-low oil prices during 1998 and early 1999, but with the rebound in oil prices over the past year, has begun to recover somewhat. For 1999, Iran's gross domestic product (GDP) grew by 2.5%. For 2000, Iran's real GDP is expected to grow at a more rapid, 4.2% rate. Besides persistent unemployment and inflation, other problems faced by Iran's economy include: a rapidly growing, young population with limited job prospects; heavy dependence on oil revenues (about half the state's budget and 80% of the country's hard currency earnings); $16 billion in external debt (including a high proportion of short-term debt); expensive state subsidies on many basic goods; a large, inefficient public sector and state monopolies (bonyads, which control at least a quarter of the economy and constitutionally are answerable only to supreme leader Ayatollah Ali Khamenei); and international isolation and sanctions.

In September 1999, President Khatami announced an ambitious program to privatize several major industries, including communications, post, rail, and tobacco, as part of the "total restructuring" of the Iranian economy called for in the country's latest five-year economic plan (which begins in March 2000). Among other measures, a partial float of the Rial, is being considered, as is the privatization of some 2,400 state-owned firms. Also, Iran is attempting to diversify by investing some of its oil revenues in other areas. Iran also is hoping to attract billions of dollars worth of foreign investment to the country by creating a more favourable investment climate. This would involve a variety of measures, including possible constitutional amendments, reduced "red tape," reduced restrictions and duties on imports, creation of free-trade zones, and increased safety of foreign investments. In October 1999, Iran's government reportedly decided to open up its mining and metals sectors to foreign investors.

On February 18, 2000, Iran held its sixth parliamentary elections since the 1979 Islamic revolution. Results of the elections indicated an overwhelming (over 70% of the vote) victory for the reformist coalition -- called the Second of Khordad Movement, after the date on the Iranian calendar of President Khatami's election (in 1997). In the wake of the election, US President Clinton called for a "constructive partnership with Iran." Shortly after the reformist coalition victory, a leading conservative, Mohammad Reza Bahonar, acknowledged that although "we will not change our principles and positions...it is natural that we should reconsider our policies and methods." The effect of Iran's recent elections on the country's energy sector at this point remains uncertain.

Sanctions

The Iran-Libya Sanctions Act (ILSA) of 1996 imposes mandatory and discretionary sanctions on non-US companies which invest more than $20 million annually (lowered in August 1997 from $40 million) in the Iranian oil and gas sectors. Also, in early 1995, President Clinton signed two executive orders which prohibited US companies and their foreign subsidiaries from conducting business with Iran. The orders also banned any "contract for the financing of the development of petroleum resources located in Iran." As a result, US-based Conoco was obligated to abrogate a $550-million contract to develop Iran's offshore Sirri A and E oil and gas fields. After Conoco pulled out of the Sirri project, France's Total and Malaysia's Petronas were awarded the contract. On August 19, 1997, President Clinton signed Executive Order 13059 reaffirming that virtually all trade and investment activities by US citizens in Iran are prohibited.

Caspian Energy

Iran sees itself as a natural (geographically and economically) transit route for oil and gas exports from the landlocked Central Asian countries to world markets. This vision is complicated, however, by political considerations, particularly the US policy opposing pipelines through Iran (the United States has made the construction of an oil pipeline from Baku, Azerbaijan to Ceyhan, Turkey the centrepiece of its Caspian policy). In November 1999, two multi-billion-dollar agreements were signed -- by Turkey, Azerbaijan, Georgia, and Turkmenistan -- regarding development of the Baku-Ceyhan oil pipeline.

Crude Swaps

In order to get around restrictions in dealing with Iran, several firms have proposed oil "swaps" involving the delivery of Caspian oil to refineries in northern Iran, while the same amount of Iranian oil is exported through Persian Gulf terminals. According to Iranian Oil Minister Bijan Namdar-Zangeneh, Iran is planning to re-tool its oil infrastructure to accommodate such swaps, including construction of a $400-million, 240-mile pipeline from the Caspian area via Iran's Caspian port of Neka to refineries in northern Iran and to Tehran. NIOC already has reached agreement with a Chinese consortium on the technical aspects of the project, which is expected to transport 175,000 bbl/d of Caspian crude within two years, and ultimately up to 370,000 bbl/d. Also, European oil trading company Vitol has expressed interest in financing the project. In January 2000, US Ambassador to Azerbaijan, Stanley Escudero, said that transit of oil from Azerbaijan would be a "mistake."

Oil

Iran holds 90 billion barrels of proven oil reserves, or roughly 9% of the world's total. The vast majority of Iran's crude oil reserves are located in giant onshore fields in the Khuzestan region near the Iraqi border and Persian Gulf terminus. More than half of Iran's 40 producing fields contain over one billion barrels of oil. The onshore Ahvaz, Marun, Gachsaran, Agha Jari, and Bibi Hakimeh fields alone account for about two-thirds of Iran's oil production. Most of Iran's crude oil is low in sulphur, with gravities in the 30°-39° API range.

In October 1999, Iran announced that it had found its biggest oil discovery in 30 years, a giant onshore field called Azadegan located in the southwestern province of Khuzestan. According to Iran's Oil Minister Zanganeh, the Azadegan field could contain 26 billion barrels of oil, with potential production of 400,000 bbl/d. Also according to Zanganeh, development of Azadegan could begin by the end of March 2001. The field reportedly is to be developed using the "buy-back" model (see below).

Since 1995, the National Iranian Oil Company (NIOC) has made several sizable oil discoveries. These include the 2.5-billion-barrel Darkhovin field, located offshore Abadan and containing low sulphur, 39° API crude oil. NIOC aims for initial production from Darkhovin of 30,000 barrels per day (bbl/d), with a second phase peak of 60,000 bbl/d. Production goals are still uncertain, though, and further appraisal is required.

Production

Iran is OPEC's second-largest oil producer, with average 1999 crude oil production of 3.6 million bbl/d. Iran's current sustainable production capacity is estimated as high as 4 million bbl/d, but this figure is controversial since Iran may have maintained production levels at some older fields only by using methods which have permanently damaged the fields. Iran produced 6 million bbl/d in 1974, but has not produced more than 3.7 million bbl/d since the 1978/79 Iranian revolution.

In June 1998, Iran agreed to reduce its production by 305,000 bbl/d, and in March 1999, Iran agreed to a further cut of 264,000 bbl/d as part of an OPEC quota agreement As of April 1, 1999, Iran's new production quota was set at 3.359 million bbl/d. With production running around 3.5 million bbl/d as of early 2000, and with consumption of 1.2 million bbl/d, Iran currently is a net exporter of around 2.3 million bbl/d. Around half of Iran's oil exports go to Asian markets, with the remainder going to Europe and Africa.

Foreign Investment

The Iranian constitution prohibits the granting of petroleum rights on a concessionary basis. However, the 1987 Petroleum Law permits the establishment of contracts between the Ministry of Petroleum, state companies and "local and foreign natural persons and legal entities." In August 1998 the ministry announced invitations to bid on 43 petroleum projects worth some $8 billion in what has come to be known as the "buy back" investment methodology. Buy back contracts are essentially risk-service contracts according to which the contractor funds all investments. The contractor recovers its investment from a commercial field and receives remuneration from NIOC. The remuneration is based on an agreed contractor rate of return (15-17%) and is paid in the form of NIOC's allocation of a share of production equal in value to the amount due. This system has drawbacks for both sides: by offering a fixed rate of return, NIOC bears all the risk of low oil prices. If prices drop, NIOC has to sell more oil or gas to meet the compensation figure. At the same time, companies have no guarantee that they will be permitted to develop their discoveries, let alone operate them. US law permits American companies to buy the bid packages ($10,000 each), but not to submit proposals. Several US firms are reportedly interested in the buy back offers, including Chevron, Arco, Kerr-Mcgee, Unocal, Conoco and Mobil. Arco and Mobil have officially notified Iran that they are interested in the projects and have applied to purchase oil field data.

The first major project under the buy back investment scheme became operational in October 1998, when the offshore Sirri A oil field (operated by Total and Malaysia's Petronas) began production at 7,000 bbl/d (Sirri A currently is producing around 20,000 bbl/d). The neighbouring Sirri E field began production in February 1999, with production expected to reach 100,000 bbl/d. In March 1998, Canada's Bow Valley Energy and UK's Premier Oil signed a $270-million deal to develop the offshore Balal field. The field, which contains some 80 million barrels of reserves, will produce up to 40,000 bbl/d, possibly beginning in late 2001. Bow Valley joined with Premiera after Indonesia's Bakrie Minarak Petroleum pulled out of the project due to financial problems stemming from the Asian economic crisis. In December 1999, the Indian Oil Corporation and the Oil and Natural Gas Corporation reportedly agreed to acquire 35% equity in Balal.

In March 1999, France's Elf Aquitaine and Italy's ENI/Agip signed a $540-million (in capital expenditures) deal for a secondary recovery program on the offshore Doroud oil and gas field near Kharg Island. The program is intended to boost production from current levels of around 150,000 bbl/d to as high as 220,000 bbl/d. Production is scheduled to begin in 2000 and peak in 2003, continuing for another 25 years.

Onshore Developments

NIOC's onshore field development work is concentrated mainly on sustaining output levels from large, aging fields. Consequently, enhanced oil recovery (EOR) programs, including gas injection, are under way at a number of fields, including Marun, Karanj, and the presently inactive Parsi fields. EOR programs will require sizeable amounts of natural gas, infrastructure development, and financing.

Although NIOC has run into difficulties in implementing EOR programs at some of its fields mentioned above (i.e., Agha Jari, Binak, Kupal, and Ramshahr) fields, it has been successful in many other cases. One example is NIOC's development work at Gachsaran, which contains in-place reserves of 53 billion barrels and a large-scale gas injection capacity which should help increase production.

Offshore Developments

As of 1998, Iran was producing about 500,000 bbl/d of crude oil from eight operational offshore fields. The Doroud 1&2, Salman, Abuzar, Forozan, and Sirri fields comprised the bulk of Iran's offshore output, all of which is exported. Iran plans extensive development of existing offshore fields and hopes to raise its offshore production capacity to 1 million bbl/d in coming years. It is estimated that development of new offshore Persian Gulf and Caspian Sea oil fields will require investment of $8-$10 billion.

The 105-million barrel Balal field, discovered in the 1970s by an ARCO/Murphy consortium, was never developed even though an oil pipeline connecting the field to the Lavan Island export terminal was laid. As mentioned above, Canada's Bow Valley Energy Ltd. is now conducting detailed engineering work, including a 3-D seismic survey, on the Balal field. Balal likely will require extensive water injection and other secondary recovery methods, especially in later years.

On November 14, 1999, Shell announced that it had been chosen for an $800-million project to develop the Soroush and Nowruz offshore oil fields. These fields are located about 50 miles west of Kharg Island and contains estimated recoverable reserves of 400 million barrels of mainly heavy oil. Soroush was one of the original 11 projects put out for tender by NIOC in 1995, and the project calls for Shell to raise output at Soroush to 100,000-150,000 bbl/d (from 60,000 bbl/d currently), and at Nowruz to 90,000 bbl/d. The Shell deal is potentially problematic in that it would appear to be in violation of US sanctions under ILSA.

NIOC also would like to develop five oil and gas fields in the Hormoz region (Henjam A (HA), HB, HC, HD, and HE), the A field near Lavan Island, the Esfandir field near Kharg Island, and two structures near the South Pars gas field. According to NIOC, the five Henjam fields hold an estimated 400 million barrels of oil and have a production potential of 80,000 bbl/d.

Refining

As of January 2000, Iran had nine operational refineries with a combined capacity of 1.47 million bbl/d. In order to meet burgeoning domestic demand for middle and light distillates, Iran has imported refined products since 1982, and is attempting to boost its refining capacity to 2 million bbl/d. Two planned grassroots refineries include a 225,000-bbl/d plant at Shah Bahar and a 120,000-bbl/d unit on Qeshm Island. The $3-billion Shah Bahar refinery project was approved by the government in late 1994 and would be built by private investors.

Natural Gas

Iran contains an estimated 812 trillion cubic feet (Tcf) in proven natural gas reserves -- the world's second largest and surpassed only by those found in Russia. The bulk of Iranian gas reserves are located in non-associated fields, and has not been developed, meaning that Iran has huge potential for gas development. Besides domestic consumption, which is growing rapidly, Iran also has the potential to be a large natural gas exporter. In 1998, Iran produced about 1.9 Tcf of natural gas. Currently, natural gas accounts for around 40% of Iran's total energy consumption.

Iran's largest non-associated natural gas field is South Pars, geologically an extension of Qatar's 241-Tcf North Field. South Pars was first identified in 1988 and originally appraised at 128 Tcf in the early 1990s. However, NIOC-sponsored studies conducted in mid-1996 indicate that South Pars contains an estimated 240 Tcf of gas, of which a large fraction will be recoverable, and at least 3 billion barrels of condensate. Iran's other sizable non-associated gas reserves include the offshore 47-Tcf North Pars gas field (a separate structure from South Pars), the onshore Nar-Kangan fields, the 13-Tcf Aghar and Dalan fields in Fars province, and the Sarkhoun and Mand fields.

The dual Aghar-Dalan field development has been one of National Iranian Gas Company's (NIGC) recent successful gas utilization projects. Since coming on line in mid-1995, the Aghar and Dalan fields have produced approximately 600 million cubic feet per day (Mmcf/d) and 800 Mmcf/d, respectively. Gas from both fields is processed at a $300-million gas processing facility at the Dalan field, which is also the location of a 40-MW, gas-fired power plant. Most of the treated gas from the Dalan processing plant is carried through a 212-mile pipeline for re-injection in the Marun field and other oil fields in Khuzestan province.

New Field Development Projects

On September 29, 1997, Total signed a $2-billion deal (along with Russia's Gazprom and Malaysia's Petronas) to explore South Pars and to help develop the field during Phase 2 and 3 of its development. NIOC estimates that South Pars has a gas production potential of up to 8 billion cubic feet per day (Bcf/d) from four individual reservoirs, possibly beginning in 2001. Phase I, currently scheduled for completion by the end of 2000, involves production of 900 million cubic feet per day (Mmcf/d) of natural gas and 40,000 bbl/d of condensate. This first phase is being carried out by the Petroleum Development and Engineering Company (PEDEC), an affiliate of NIOC, while Total's consortium is responsible for Phases 2 and 3. In August 1999, Total signed a $110-million contract with Hyundai Heavy Industries for construction of twin undersea pipelines from South Pars to onshore facilities at Assaluyeh. As of late 1999, the future of South Pars Phases 4 and 5 remained uncertain, with Shell and Gazprom both claiming to be in the running.

In addition to South Pars, Iran aims to develop the 6.4-Tcf, non-associated Khuff (Dalan) reservoir of the Salman oil field. Salman straddles Iran's maritime border with Abu Dhabi, where it is known as the Abu Koosh field. NIOC is seeking to develop the Khuff reservoir, which could lead to the production of 500 Mmcf/d of non-associated gas, along with the 120,000 bbl/d of crude oil that is now being produced from a shallower reservoir. Salman gas could either be exported to Dubai's Jebel Ali or to domestic locations at Qeshm Island and Badar Mogham. The project cost is estimated at slightly under $600 million for a two-platform development.

The 47-Tcf North Pars development will be integral to Iran's long-term gas utilization plans. In early 1994, Shell completed a feasibility study on the field. Development plans call for 3.6 Bcf/d of gas production, of which 1.2 Bcf/d would be re-injected into the onshore Gachsaran, Bibi Hakimeh, and Binak oil fields. The other 2.4 Bcf/d would be sent to the more mature Agha Jari oil field. Negotiations on the field stalled in 1995, but Shell reportedly renewed its interest in 1998.

Natural Gas Exports

Although domestic gas consumption is growing rapidly, including use as a motor fuel, Iran continues to promote export markets for its natural gas. Possibilities include pipelines to Turkey, Armenia, Europe, Pakistan, and India, plus the possibility of an LNG facility for producing exports to Asia.

In 1996, Iran and Turkey signed a $20-billion agreement that calls for Iran to supply Turkey with natural gas over a period of 22 years. Exports of Iranian gas to Turkey were slated to start in 1999 at an initial rate of 300 Mmcf/d and rise to a level of 1,000 Mmcf/d in 2005. In November 1998, Turkey began construction of a 623-mile pipeline that could transport gas westward from Iran. In January 2000, Iran said that it accepted Turkey's request to delay the purchase of Iranian natural gas until September 2001. Turkey said that it had been unable to complete its portion of the pipeline due to economic problems.

Electric Power

Iran has installed power generation capacity of about 27 gigawatts (GW), with around 64% of thermal plants natural gas-fired. With power demand growing rapidly, Iran is adding significant generation capacity -- both thermal and hydroelectric. The largest hydro project is the 2,000-MW Godar-e Landar dam. In March 1999, the second phase of construction began on the Masjed-Soleyman hydroelectric power plant in Khuzestan province. The project will increase generation capacity in Khuzestan by 2 GW.

A number of new power plants have come online recently in recent years in Iran, including the Mitsubishi-built, 2,000-MW Shahid Rai thermal power station in Qazvin, a 1,290-MW combined-cycle plant in Rasht, and a doubling of the Tabriz power plant's capacity to 1,500 MW. Iran continues to add power generating capacity at a rapid pace. According to Minister of Energy Habibollah Bitaraf, Iran's annual power consumption is growing and Iran's power generation sector will require billions of dollars in foreign investment over the next few years. Iran has received offers for investment in the form of loans and build-operate-and-transfer-contracts (BOT). BOT contracts allow the investing company to build and operate the generating facility for a period of 15-20 years, after which time the plant is turned over to the Energy Ministry. Negotiations have taken place with international energy firms on expansion plans for power plants at Bandar Abbas, Shaid Rajai, Alborz, Ramin, and Kerman.

In 1998, Iran's deputy energy minister said that Iran would welcome the participation of European and U.S. private investors in the planned privatization of the country's power generation industry. Breaking up the state power generation monopoly (Tavanir) into competing private companies and reducing large state subsidies are two important proposed measures aimed at increasing electric generation and transmission efficiency, reducing an estimated $4 billion in wasted electricity and attracting foreign investment.

Nuclear

On October 3, 1997, the head of Iran's Atomic Energy Agency (Gholamreza Aghazadeh, the former Oil Minister) announced that Iran would attempt to meet 20% of the country's electricity demand through nuclear power. Aghazadeh said that Iran had decided to build a second 1,000-MW unit at the Bushehr nuclear power complex as soon as work is completed on the current unit being built by the Russians. Aghazadeh further said that Iran was discussing further nuclear power plant deals with Russia and China.

Currently, Iran has five small nuclear reactors, one in Tehran and four in Isfahan. Iran claims that its nuclear power is for peaceful purposes and that it will help free up oil and gas resources for export, thus generating additional hard-currency revenues. In February 1998, the U.S. State Department reaffirmed U.S. opposition to Iran's nuclear program. The United States has argued that Iran has sufficient oil and gas reserves for power generation, and that nuclear reactors are expensive, unnecessary, and could be used for military purposes. Iran is a signatory to the Nuclear Non-Proliferation Treaty.

Work on Bushehr had begun in 1974, but was halted (80% complete) following the 1979 Islamic Revolution. In January 1995, progress on Bushehr resumed when Russia signed a $780-million contract to complete the facility. The Russian deal calls for completion of the two 1,300-MW pressurized-light water units as well as the supply of two modern VVER-440 units. The United States strongly opposes the project and has in the past provided Russia with information pointing to the existence of an Iranian nuclear weapons program. Despite this, the Russians have proceeded, although slowly, with work on Bushehr. A final completion date currently remains uncertain.

Environment

In the context of its oil-based economy, environmental issues in Iran only recently have become important. Ongoing air pollution in urban areas, which reached a crisis level in Tehran in December 1999, have highlighted the need to improve Iran's environmental record. The rush to develop oil and gas resources in the Capsian Sea makes oil pollution in the Caspian a real environmental threat.

Huge increases in energy consumption over the past 20 years have contributed greatly to pollution levels as Iran's carbon emissions have nearly tripled over the same time span. Large numbers of old, inefficent cars on the road lacking catalytic converters account for much of the country's carbon emissions. Together with the widespread use of low-quality, leaded gasoline, this combination has led to noxious, black smoke spewing from cars creating a cloud of smog above many cities, especially Tehran.

In addition, Iran's abundance of fossil fuel resources has tended to discourage the country's incentive to shift to cleaner alternative energy sources for its energy needs. As Iran continues to struggle with air pollution in the 21st century, however, the country likely will need to shift its energy mix in order to avert an environmental crisis.