Chronicle of the Middle East and North Africa

Energy Sector in the Face of the Nuclear Programme

Energy Sector in the Face of the Nuclear Programme

Map 5. Outline of nuclear projects in Iran.
Map 5. Outline of nuclear projects in Iran. Click to enlarge.

Barring possible aerial bombardment from American or Israeli air forces in select locations, and the greater backlash that could unleash, Iran does not share the internal security risks of its energy-giant neighbour Iraq. However, sanctions related to financial and material support for terrorist activities abroad and the serious international concern related to Iran’s alleged nuclear weapons programme has critically affected Iranian energy – with persistent effects in the medium term.

While Iranian support for Hezbollah, Hamas and Shia militias in Iraq continues to attract attention, diplomatic efforts are currently focused on Iran’s nuclear programme. Iran is a signatory to the 1968 Nuclear Non-Proliferation Treaty, but there is international concern about its uranium enrichment programme, which may be diverted away from its ostensible civilian purposes to build a nuclear bomb.

Iran has already cleared the biggest hurdle to creating a nuclear bomb in learning to make the fissile material that fuels the massive blast. At Iranian facilities, centrifuges spin at supersonic speeds to separate the explosive uranium-235 isotope from uranium ore. The machines refine the metal to low enrichment levels to make fuel for nuclear power plants, but they can also make higher grade material for bombs.

As a consequence, in 2006, the UNSC passed Resolution 1696 and imposed sanctions after Iran refused to suspend its enrichment programme. The UNSC has adopted six resolutions since 2006, requiring Iran to stop enriching uranium and cooperate with the International Atomic Energy Agency (IAEA). Sceptics are not satisfied by IAEA verification, however. They point to the example of Iran’s two main uranium enrichment plants – a hardened bunker in Natanz and a mountainside chamber in Fordo – that Iran acknowledged only after they were exposed by Iranian resistance groups outside the country (see Map 5). In response, the IAEA is seeking more extensive inspections.

The US and EU have imposed their own sanctions on Iranian oil exports and banks. The EU imposed restrictions on trade in equipment which could be used for uranium enrichment and froze the assets of individuals and organizations that it believed were helping to advance the country’s nuclear ambitions. It also banned the individuals from entering EU member states. In January 2012, the EU additionally froze assets belonging to the Central Bank of Iran and banned all trade in gold and other precious metals with the bank and other public bodies. Six months later, an EU ban on the import, purchase and transport of Iranian crude oil came into force.

The 27 member states had until then accounted for about 20% of Iran’s oil exports. European companies were also prevented from insuring Iranian oil shipments, having previously underwritten 90% of them. In March 2012, Swift, the Brussels-based body that handles global banking transactions, cut Iranian banks from its system, making it almost impossible for money to flow in and out of Iran via official channels. In October 2012, the EU banned any transactions with Iranian banks and financial institutions, as well as the import, purchase and transportation of natural gas from Iran, the construction of oil tankers for Iran, and the flagging and classification of Iranian tankers and cargo vessels. In February 2012, the US froze all property of the Central Bank of Iran and other Iranian financial institutions, as well as that of the Iranian government, within the United States.

The US’s view is that sanctions should target Iran’s energy sector, which generates about 80% of government revenues, and try to isolate Iran from the international financial system. Additional sanctions implemented in February 2013 effectively bar Iran from repatriating earnings from its oil exports, depriving Tehran of much-needed hard currency. As with all other sanctions, countries that violate the new requirements risk being expelled from the US financial system, among other penalties.

Iran has repeatedly questioned the legal basis of demands to suspend work, and before it made any concessions it wanted what it calls its “right” to enrich uranium recognized, noting that the Nuclear Non-Proliferation Treaty does not ban such enrichment. However, evidence that the heavy sanctions are taking a toll became apparent in November 2013, when world powers agreed to a temporary accord setting limits on the Islamic Republic’s nuclear programme – while in fact accepting an Iranian enrichment programme – in exchange for about $7 billion in sanctions relief. The Joint Plan of Action (JPOA) was established between Iran and the five permanent members of the UNSC (United States, United Kingdom, France, Russia and China) plus Germany (P5+1).

The JPOA aims to reach a long-term comprehensive agreement that ensures that Iran’s nuclear programme is peaceful, which may lead to the lifting of international sanctions. Under the first extension, Iran agreed to maintain caps on the amount of material it produces during the negotiations. The IAEA, which is tasked with verifying that enrichment is used strictly for peaceful purposes, has tracked Iran’s build-up of 5% and 20% enriched uranium.

The stockpile of higher grade material, which is the bigger concern because it could be further purified into weapons grade at short notice, has been reduced by half by diluting it to no more than 5% enrichment. Iran also agreed to improve cooperation with monitors, halt advanced centrifuge installation and the use of centrifuges not yet in operation. It pledged to stop work on its Arak heavy water reactor, which, if it became operational, could produce plutonium and give the country a second path to nuclear weapons.

On Map 5, numbers 4 and 6, respectively,  indicate the enrichment complexes at Fordo and Natanz. The Arak heavy water reactor could produce plutonium – potential weapons material – as a by-product. Curbing activity at Natanz, Fordo and Arak has been largely viewed as a success in the interim agreement.

Effects of sanctions on Iranian energy and the outcome of the November talks

Figure 2. Iran crude production since January 2010. Source: EIA.
Figure 2. Iran crude production since January 2010. Click to enlarge.

The sanctions detailed in the previous section are some of the world’s most comprehensive and the implications for oil exports have been severe. Production has fallen from an average of 3.7mbbl/d in 2010 and just over 3.6mbbl/d in 2011 to an average of 2.68mbbl/d in 2013, as can be seen in the graph below.

As for medium-term consequences, the IEA expects Iran’s oil production capacity to remain largely unchanged to 2020, growing perhaps by 50,000bbl/d to 3.11mbbl/d – capacity growth well below what some had hoped for Iran had the nuclear issue not reached its current critical stages.

Envoys representing Iran and a group of world powers agreed on 24 November 2014 to extend nuclear talks until 30 June 2015 after failing to overcome differences at negotiations in Vienna. Many had hoped that the breakthrough deal would have emerged at this time. The extension will keep in place the terms of the JPOA interim agreement that was struck a year ago and $700 million in Iranian assets will be unfrozen per month. Western officials said they were aiming to secure an agreement on the substance of a final accord by March 2015 but that more time would be needed to reach a consensus on the all-important technical details.

Iranian President Hassan Rouhani has said the gap between the sides had narrowed at the latest round of talks in Vienna. But he made clear that Tehran was taking a firm line. “There is no question the nuclear technology and facilities of the Islamic Republic of Iran will remain active and today the negotiating sides know that pressure and sanctions against Iran were futile,” he said.

He faces heavy pressure from hard-line conservatives at home who have already blocked his drive to ease restrictions on Iranians’ individual freedom. But John Kerry, the US Secretary of State, defended the decision not to abandon the talks. “We would be fools,” he said, raising his voice, “to walk away from a situation where the break-out time [for Iran to develop a nuclear weapon] has already been expanded rather than narrowed, and the world is safer because this programme is in place.”

Indeed, P5+1 and Iran managed to conclude a framework agreement in the first days of April 2015 after marathon negotiations. This deal is expected to pave the way to a full nuclear deal before July 2015.  Iran agreed  to severely reduce its enrichment programme and to accept stricter inspection of its nuclear installations.  In turn the P5+1 will lift  most of its sanctions against the Islamic republic, which will enable Iran to expand its oil export in the future. Analysts  predicted negotiations about the details would be difficult but pointed out that both sides did want to reach a full agreement. In Iran, the framework agreement was praised in Friday sermons and by the commander of the Revolutionary Guard. This signalled that Supreme Leader ayatollah Ali Khamenei accepted the wide-ranging Iranian nuclear concessions. From their side, as expected,  Israel and members of the US Congress objected fiercely, but supporters of an agreement were more numerous.

What Iran stands to gain

Figure 3. Nominal GDP Trajectories with ‘Agreement’ versus ‘No Agreement’. Source: The Institute of International Finance.
Figure 3. Nominal GDP Trajectories with ‘Agreement’ versus ‘No Agreement’. Click to enlarge.

As mentioned, the IEA does not expect high growth out to 2020 but maintains that, even had an agreement been reached on 24 November 2014 or if an agreement is reached by June 2015, it will still be post-2018 before any significant volume increases will materialize, simply because of the slow-moving nature of the industry and historical experience of (uninhibited) operations in Iran.

Nevertheless, were a deal to be struck a full lifting of sanctions would occur and certainly improve production prospects beyond 2020. Oil Minister Bijan Namdar Zanganeh has stated that Iran could boost output by 700,000bbl/d within two months of the removal of sanctions – or nearly all production currently off the market due to sanctions. Furthermore, signalling the Islamic Republic’s readiness to court American business interests amid a potential deal, Zanganeh mentioned that he would like Total, Shell, Eni, Statoil, BP, ConocoPhillips and Chevron to return to the country.

As discussed, Western companies are still banned by their governments from investing in Iran’s oil and gas fields, and June 2014 was the first time that Iran named particular US companies it would like to enter the country. In the 1990s, ConocoPhillips and Chevron tried to enter Iranian oil projects, but their efforts were scuttled when Washington banned such investments for American companies. Many European companies, including Total and Shell, did move in before being forced to pull out completely when the EU forbade their presence in 2010. BP’s name stands out in this group of European companies because it did not enter Iranian projects after the Islamic Revolution. BP’s predecessor, Anglo-Iranian Oil, played a controversial role under the previous regime of the Shah. A BP spokesman said Iran “has not had access to a lot of recent technological developments in the oil and gas industry”.

Additionally, although Iran’s aspirations to build a liquefaction facility date back to the 1970s, the country has yet to build one. The lifting of sanctions could finally see liquefaction facilities introduced for the world’s second-largest reserve holder. Pipeline projects to gas-hungry MENA neighbours, which are currently on hold, could also be realized. According to the Cato Institute, the economy would boom, with real GDP growth rates forecast during the fiscal years 2015/16 and 2016/17 to jump by 4.1 and 4.6 percentage points respectively. And for those two fiscal years alone, the cumulative GDP would be $125 billion greater than if the sanctions were left in place.

The election of President Hassan Rouhani in June 2013 brought widespread expectations of economic improvements and greater international engagement among the Iranian public. The supreme leader, Ayatollah Ali Khamenei, has the last word, but his role is to adjudicate between the claims of an elite made up of thousands of politicians, clerics, generals, academics and business people.

They form an ever-shifting pattern of competing factions and coalitions which, while hardly amounting to a democracy, approximates a political marketplace and, as former President Ahmadinejad discovered, policies that tack away from the consensus do not last. If a decision is reached, it will track the consensus reached in this group. The hope is the significant economic and development boom that will likely occur following a deal eliminating Iran’s nuclear weapons capability will prove to be an outcome of greater interest to this influential elite than the present path which maintains strict sanctions that are crippling Iran’s energy potential.