Relief from UN sanctions unlocks few energy-related investment opportunities in Iran, but the long-term potential is significant. Carlo Svaluto Moreolo reports
Iran possesses the world’s fourth largest oil reserves and second largest gas reserves, according to the United States’ Energy Information Administration (EIA). But the country’s energy-superpower status has been jeopardised. The complex set of sanctions applied by the US, the EU and the United Nations in response to Iran’s nuclear programme has severely affected the energy industry.
A 2015 report from the EIA highlights how the measures enacted by the US and the EU between 2011 and 2012 disrupted Iran’s oil exports. IMF data shows that in the 2012-13 fiscal year Iran’s oil and natural gas export revenues dropped by 47% to $63bn (€55bn), and fell a further 10% the following year.
The lifting of UN sanctions at the beginning of this year was therefore greeted with enthusiasm, as it promises to revive the industry and unlock opportunities for foreign investors. The sanctions were lifted following the agreement between Iran and the P5+1 countries (China, France, Russia, the UK, the US plus Germany) about the nuclear programme.
However, the lifting of sanctions does not mean Iran is sanction free. EU sanctions were lifted, as were many sanctions applied by the US. But as they were removed in January this year, the US Department of State issued a document detailing which restrictions would remain in place. The document clearly stated that “US persons, including US companies, continue to be broadly prohibited from engaging in transactions or dealings with Iran or its government”.
Yet, the Iranian economy will undoubtedly benefit from the partial reopening. Emre Akcakmak, portfolio manager at East Capital, believes oil exports will continue trending up. Crude exports surpassed 2m barrels per day (b/d) in March, according the National Iranian Oil Company, the oil and gas producer owned by the Iranian Ministry of Petroleum. This compares to 1m b/d exported in 2014, according to OPEC.
Akcakmak explains that rising crude exports provides immediate support for the country’s budget and the economy. But, more importantly, Iran’s financial assets that were frozen as a result of the sanctions should flow back over time. The size of these assets could be $30bn, which corresponds to about 8% of GDP.
The post-sanction world also sees the opening of the global payment systems such as SWIFT, which will be a “massive boost”, according to Akcakmak. He adds: “As confirmed by the wave of investors visiting Tehran, we expect both FDI [foreign direct investment] and portfolio investments to grow over time and contribute to future growth. In addition to their immediate impact, we think that FDI and other different forms of investments will also prepare the ground for the long-term growth of the economy. We also expect the pent-up demand that is driven by Iran’s young population to contribute to the positive momentum in the economy.”
However, the extent to which the energy sector will be affected is difficult to establish at this point. “We expect future efficiency and modernisation investments to have a greatly positive effect on the sector,” says Akcakmak. But he concludes with a note of caution: the impact may be felt slower than expected. “Global energy players are still hesitant to enter the market, due to worries over different layers of sanctions and potential difficulties in doing business as a foreign entity.”
Although the sanctions have only been lifted for a few months, it is already possible to see the impact. Akcakmak notes how the Iranian equity market has been among the best performers in the world during the first quarter of 2016, mainly driven by the positive sentiment.
However, Erik van Dijk, principal at LMG Emerge, a consultancy firm with an expertise in emerging and frontier markets, believes that the first few sanction-free months have been “disappointing” from an Iranian perspective.
Van Dijk says the assets Iran is entitled to could be could be closer to $50bn. But the flow of assets back into the country has been slower than expected. This is clearly a disappointment to the Iranian entities that are entitled to them, including the government. “There have been all kinds of delays there, and this is the last thing we should want to keep the country on board,” adds van Dijk.
Getting those assets back into the country, he argues, would be a much-needed relief for the Iranian economy, at a time when Iran is devising a long-term strategy for oil production.
The country has a difficult relationship with OPEC. The organisation is on the cusp of agreeing a production freeze that would speed up the rebalancing of the oil market, while Iran seems resolute in its intention to increase production. In April, local media reported that petroleum minister, Bijan Zangeneh, planned to raise production to 4m b/d by March 2017, a dramatic increase from current levels.
But increasing production at such a fast pace, says van Dijk, would hurt the country in the long term, as its production costs are much higher than other high-production OPEC countries, such as Saudi Arabia. Therefore, Iran’s immediate dilemma is whether to wait for its assets to be repatriated, to compensate for lost oil revenue, or to speed up the increase in oil production.
Increased co-operation with Russia and China, rather than with the West, is more likely in the short term, according to van Dijk. Iran and nearby Russia signed a trade deal almost two years ago, and energy was on the agenda at official meetings between the two countries that took place this year.
The potential for co-operation between Iran and Russia in the gas sector is significant, and European firms might be missing out. Djavad Salehi-Isfahani, economics professor at Virginia Tech and senior fellow of the Brookings Institution, observes that Europeans are “intimidated” by the US unilateral sanctions in place.
“While Iranians wait to get the full benefit of the removal of the sanctions, Europeans seem to be debating among themselves what it is that they can do exactly without incurring the US sanctions. This is even though Europe has fully removed the UN sanctions,” says Salehi.
But the long-term potential is significant, not just in oil and gas, but also in the wider energy sector and other sectors.
“I think of Iran as a country without much foreign debt, where even though there is no cash to pay for goods and services, investors will be the first to be paid back when the investments bear fruit,” says Salehi. “Iran is a fresh place with lots of promise.” Countries that do invest, in energy or other sectors, are likely to reap good benefits, assuming that the rapprochement with the West continues and Iran maintains a pro-business environment in the coming years,” he concludes.
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