by Dave Cohen
What [name a country here] has succeeded in creating is not an economy impervious to shocks, but merely one which enables their consequences to be postponed to a later date.
— Peter Schiff
Violence erupted in Iran last week when Ahmadinejad's government imposed gasoline rationing, limiting drivers to 100 litres (26.39 gallons) per month of petrol at the subsidized price of about $0.42 per gallon. Angry protesters burned gas stations as they denounced the belt-tightening measure and the politicians who imposed it (photo below, source). Sanctions on Iran, the Islamic Republic's policies, and subsidies on gasoline in other countries adversely our ability to cope with a liquid fuels peak that is likely to arrive by 2015. The rioting also revealed the sacrosanct nature of driving, and just how tough it's going to be to change people's transportation habits all over the world to mitigate the effects of the crisis.
Iran's upstream oil industry is a mess. The UN has imposed sanctions due to Iran's game of hide and seek with uranium enrichment, but those restrictions mostly affect their nuclear ambitions. As detailed in U.S. puts squeeze on Iran's oil fields (reprint from Los Angeles Times, January 7, 2007), renewed U.S. pressure has dried up most foreign investment there. Iran desperately needs capital to reverse faltering production in its aging oil fields, where geological declines are estimated to be 8% or greater.
According to Fereidun Fesharaki, president of FACTS Inc. in Honolulu, cited in Gas use at issue in Iran as oil production sags (Oil & Gas Journal, May, 2006) --
Iran is losing 350,000 b/d/year of oil production capacity ... and the decline rate could increase to 500,000 b/d/year by the end of the decade. Onshore decline rates have risen to 8%/year from 7%/year and offshore decline rates to 13%/year.
"These numbers are alarming, particularly as they come at the same time as runaway demand," Fesharaki said. "It is now possible to see a future with little or no oil export revenues within 2 decades."
Production of Ahwaz Bangestan oil field, for example, has fallen to 160,000 b/d from 250,000 b/d and will fall to 60,000 b/d within 1-2 years. A gas injection program could increase production to 220,000 b/d and maintain it at that level.
A simple calculation using Chris Skrebowski's Megaprojects (≥ 40 thousand b/d) list of upcoming oil field developments1, based on an 8% decline rate, shows that Iran's current production of 3.9 million b/d would be approximately the same in 2013 even if every project comes on-stream as scheduled. Japan's Inpex Holdings pulled up stakes in Azedegan, due in 2009, last year. India's Essar Oil is now negotiating the development rights. Phase II of the Darquain (Darkhovin) field operated by the Italy's ENI was scheduled to expand production there from 50 thousand b/d to 160 thousand b/d in 2006, but is now delayed until late 2007. Tales of Iran's rapid demise may be exaggerated, but their production has fallen off 5.8% since 2005 according to EIA supply data. Hossein Kazempur Ardebili, Iran's OPEC representative, claims that the downturn in Iran's production is due to its cartel quota restriction, stating that they have a productive capacity of 4.25 million b/d. The IEA lists Iran's spare production capacity as 5 thousand b/d. They can't both be right.
Iran's Achilles' heel (Reuters) is their rising internal liquids consumption. America's financial war on Iran is meant to exploit this weakness. The Islamic Republic's refining capacity is about 1.6 million b/d, but their downstream industry provides only about 60% of their gasoline consumption, which is growing because they are practically giving it away. Iran must import the rest, which is a considerable drain on their revenues. (Click on the image left and keep the page open.) Figure 1 shows that Iran's petrol prices are the 3rd lowest in the world, even when the 25% price hike Iran implemented in May is taken into account. Figure 2 indicates that gasoline subsidies make up an astonishing 38% of Iran's state spending. Figure 3 estimates that an Iranian citizen spends $4.49 to fill up a Honda Civic. Iran's oil production is probably maxed out now, so they can not increase exports to cover their gasoline bills. The Reuters article explains the situation —
"Sanctions have led to limited technology transfer, higher operating costs, and a much slower pace of development," said Stuart Lewis, Middle East director at energy consultancy IHS.
Iran last year embarked on a multi-billion dollar, five-year program to revamp and expand the refining system to 3 million barrels per day (bpd) from around 1.6 million bpd now. But analysts say state funding for the program is inadequate... India's Essar is in talks with NIOC [National Iranian Oil Company] to build a new $2 billion, 300,000 barrels per day plant, while China's Sinopec last year signed a deal to upgrade Iran's 170,000 bpd Arak refinery and has also upgraded plants in Tehran and Tabriz....
The country's domestic fuel consumption is rising at around 10 percent per year, encouraged by the subsidies that make its gasoline among the cheapest in the world... Fuel subsidies dampen the financial incentives to build new refinery capacity, analysts said. New plants may cut dependency on expensive imports, but they would also divert potentially lucrative crude exports to domestic refineries and the subsidized market.
With NIOC's budget so limited, the state oil company would rather channel investment to the upstream sector, analysts said. "From the financial perspective there is less incentive to do this, it is more politically driven," said Saad Rahim, analyst at Washington-based consultancy PFC Energy. "If you're NIOC and you have a billion dollars to spend, you'd rather put it towards upstream oil output."
Iran can't financially support its upstream industry, let alone make the larger downstream investments it requires to meet burgeoning gasoline demand. Trying to quench their gasoline thirst by building out their refining capacity is self-defeating for Iran in any case — hence, the rationing implemented last week. As PFC's Rahim points out, NIOC would much rather invest what money they've got in the upstream part of the business to prop up sagging production. It is clearly in Iran's best interest, and best for the global oil supply, if Iran sharply curtails their internal consumption and reinvigorates their upstream oil industry to increase exports. Presumably, many in the Iranian leadership see the wisdom in this course of action.
What are the chances that Iran can turn things around? Aside from cheap petrol, America's foreign policy, Iran's insistence on stringent production sharing agreements, their budding nuclear program, furious Tehran drivers hurt by sanctions, and fundamentalist mullahs all stand in the way. The prospects look dismal, but Supreme Leader Ayatollah Ali Khamenei supported the rationing, saying " if this huge amount [spent on imported gasoline] is gradually reduced, definitely it will be spent on people's lives, employment, investment, construction of schools and roads."
Gasoline subsidies pose grave problems in a world that is likely on the brink of a peak in world oil production. Artificially low fuel costs encourage consumption and keep that demand insensitive to price increases. From Where gasoline is cheap (CNN Money, May 11, 2007) —
"Roughly two-thirds of new oil demand is coming from countries that have subsidized oil markets," said Christopher Ruppel, a senior geopolitical analyst with the consulting firm John S. Herold. "So demand is not going to be affected if oil goes from $60 a barrel to $80."
Ruppel said China still has gasoline subsidies, although lately the government has been trying to whittle them back. The average price for a gallon of gas in Beijing is $2.44...
... but the second-highest demand growth [after China] isn't in the fast-growing economies of India or Brazil. It's Saudi Arabia, projected to consume 5.6 percent more oil next year, according to Ruppel. Iran is number three, guzzling 3.3 percent more. Russia and Egypt, which Ruppel said both have heavy gas subsidies, are also high on the list.
And the raw numbers aren't small either. The Saudis used more than 2 million barrels of oil per day in 2006, and the Iranians used 1.7 million. India, a faster-growing economy with far more people, used 2.5 million...
Looking again at Figure 1, and also Figure 4, it is evident that the bottom twelve gasoline price positions are mostly occupied by large oil producers with state-sponsored subsidies, large, growing consumers, or both. The Mexican (consumption ranks #7), Chinese (#3) and Russian (tied for #5) subsidies are more modest than those in the OPEC countries, but prices far beneath those in the wealthy OECD nations (Europe, Japan, Australia, Canada) stimulate demand nonetheless. And then there is the profligate United States, where prices are unconscionably low by the standards of the other developed countries. Whether American consumption is "subsidized" is a matter of interpretation. In the absence of a state-sponsored discount, analysts who study the real cost of gasoline and imported oil in the U.S. tend to stress cost externalities such as military spending or the many social costs. What is absolutely clear is that the prices Americans are paying at the pump in 2007 are not yet high enough to rein in growing demand.
Last week's riots in Tehran were not unique. When India raised gasoline prices 4 rupees to 47.49 rupees per liter ($3.94/gallon) and diesel by 2 rupees to 32.45/liter in June, 2006, nationwide protests followed. The Congress party revoked those price increases in the last year, despite an Indian crude basket price of $67. However, with prices now about $70, "pressure has built within the [Indian oil] industry for a rise that could revive shares of hard-hit state-run refiners such as Indian Oil Corp. (IOC) and put a mild dampener on resurgent oil demand growth." The latest report (Times of India) indicates that the oil ministry's plans to increase fuel prices will be put on hold for fear of "upsetting (political) allies" and reviving inflation.
Were gasoline prices in the U.S. to jump a few dollars following an oil supply disruption or an imposed tax — or, God Forbid, a floating cap on consumption implemented through rationing — it is easy to imagine American consumers reacting just like their counterparts in Iran and India. As things stand now, it seems likely that a variety of scapegoats would be identified and attacked without addressing the underlying problem, which is rampant, unsustainable consumption.
Subsidizing gasoline prices — wherever or however it occurs — amounts to throwing away a precious, finite resource with no regard for the consequences that will surely follow down the road. Subsidies give the illusion of abundance and undermine market mechanisms that might encourage efficiency and fuel substitutes — such as they are — as prices rise. This kind of discounting of the future may be an irremediable part of our human nature, but events in Iran now illustrate the foolishness of this kind of behavior. Can we take home the right lesson from Iran's experience? Only time will tell.
1. Skrebowski lists Yadavaran (onshore, 2011, 300 thousand b/d) and Kushk - Hosseinieh (same, 2010) as separate projects, but they are identical, only then name has changed. "Yadavaran" is now the preferred name. Iran claims that this recent discovery (reprint, Tehran Times, 2004) in the southwestern province of Khuzestan holds 3 billion barrels of recoverable oil and will support a production rate of 300 to 400 thousand b/d.