The Fuse

Elections Loom Over Iran’s Oil Industry

May 18, 2017

Guest Post by Matthew M. Reed | @matthewmreed

Matthew M. Reed is Vice President of Foreign Reports, Inc., a Washington, DC-based consulting firm focused on oil and politics in the Middle East.

Iranian oil production has come a long way since the nuclear deal went into effect and tough sanctions were lifted in January 2016.

Iranian oil production has come a long way since the nuclear deal went into effect and tough sanctions were lifted in January 2016. Over the course of last year, production climbed by some 800 thousand barrels/day—from 2.92 million b/d in January to 3.72 million b/d in December, according to OPEC’s secondary sources. Exports ultimately doubled.

OPEC data for the first four months of 2017 suggests that Iran’s oil production has hit a ceiling. It might even be slipping. Iran’s official data, which it reports directly to OPEC, is questionable but it too shows signs of a plateau. More so lately, Oil Minister Bijan Zanganeh has emphasized the oil sector’s constraints. His ministry is chronically underfunded, he complains, and foreign investment, technology and partnerships are urgently needed.

Production outlook depends on Friday’s election

Iran’s production outlook now very much depends on the outcome of the May 19 presidential election. The incumbent, President Hassan Rouhani, will face off against Ebrahim Raisi, the clear favorite of hardliners, including Supreme Leader Ali Khamenei.

President Rouhani’s signature achievement is the nuclear deal or Joint Comprehensive Plan of Action, which was finalized in July 2015 with the P5+1 (the permanent five members of the UN Security Council, plus Germany). He ran in 2013 as a moderate—in the Iranian sense. He was the “change” candidate arguing for diplomacy as the surest way to lift sanctions and end the isolation Iran endured after Mahmoud Ahmadinejad became president in 2005. When the JCPOA was announced, following almost two years of intense negotiations, Iranians celebrated in the streets. Many hoped that an economic boom would follow. However, despite the rapid recovery of Iran’s oil sector, the benefits haven’t been felt by the average citizen.

While Rouhani’s revolutionary credentials were never in doubt, his opponent Ebrahim Raisi is a hardliner’s hardliner.

While Rouhani’s revolutionary credentials were never in doubt, his opponent Ebrahim Raisi is a hardliner’s hardliner. In 1988, when he was Deputy Prosecutor General of Tehran, Raisi served on the notorious four-man “Death Committee,” which ordered the executions of 3,000 or more prisoners. He took on various roles in the judiciary after that but only assumed greater prominence last year, when he became chairman of one of Iran’s most influential state-backed charities. What Raisi lacks in charisma he makes up for with friends in high places. On matters of diplomacy and the economy—and by extension oil—Raisi and the Supreme Leader agree completely.

Raisi is deeply suspicious of foreign investment. He is convinced that Iran’s economy can be self-sufficient if only its officials and citizens find the willpower. This is not to say that trade is bad by default but rather that being dependent on others is a grave vulnerability. The sanctions era proved that when Iran’s economy and its oil exports were crippled. The “moral” solution, espoused by Supreme Leader Khamenei and parroted by Raisi, is to strive for something called the “Resistance Economy,” which would theoretically maximize Iran’s domestic potential and limit foreign influence in a variety of sectors, including oil.

President Rouhani and Oil Minister Zanganeh pay lip service to the “Resistance Economy” fantasy, but they’re pushing for tens of billions of dollars in foreign investment, specifically for the oil sector. For years, Rouhani and Khamenei have sniped at each other in dueling speeches about the economy. Zanganeh, for his part, has made the case countless times that Iran’s oil sector needs help. He recognizes that advanced foreign technology and techniques must be imported; Iran can’t develop them from scratch with no guidance. He also admits that Iran simply can’t come up with the $150 billion in capital it needs to upgrade and expand the industry.

The first casualty of a Raisi administration might be the new Iran Petroleum Contract. It was said to be complete or nearly so last summer, but hardliners stalled it with help from the Supreme Leader, who also criticized it.

The first casualty of a Raisi administration might be the new Iran Petroleum Contract. It was said to be complete or nearly so last summer, but hardliners stalled it with help from the Supreme Leader, who also criticized it. We still don’t have many details on the new framework but we know it’s designed to last longer and be more flexible, making Iran’s oil sector more attractive than ever for outsiders. Iran’s old terms were infamously short-term and rigid to the point of being prohibitive. Those that did business with Iran before the toughest sanctions were imposed, like Eni and Total, later said it was impossible to turn a profit. They won’t make the same mistake again.

Iran needs foreign investment

Shelving the new contract would be a major setback. Officials have been talking it up for years. And without foreign investment, Iran will probably fail to arrest extremely high decline rates in its oldest fields. But a Raisi administration could undermine the oil sector in other ways. Should he become president, it’s likely Raisi’s pick for oil minister will be more ideological and less realistic, at least compared to Zanganeh, who is considered a capable technocrat. Raisi will want someone who thinks like him; he’ll want a minister who favors domestic companies over foreigners no matter what. The industry would be worse off as a result.

A hardliner victory tomorrow (or in a second-round runoff) will likely increase tensions between the U.S. and Iran. According to Chief Justice Sadeq Larijani, the “most qualified candidate” is the one who will “disappoint the enemy” the most. There’s no doubt his comments were meant as a veiled endorsement of Raisi. As president, he would be expected to demonstrate Iran’s resolve in the face of U.S. pressure.

If the U.S.-Iran relationship deteriorates more, the risk of confrontation near the world’s most important oil bottleneck—the Strait of Hormuz—rises accordingly.

The risk of escalation is real. The Trump administration has already put Iran “on notice” and if the JCPOA breaks down for any reason it’s possible that oil sanctions could be re-imposed. U.S.-Iran relations worsened the last time a hardliner was in power in Iran. If the relationship deteriorates more, the risk of confrontation near the world’s most important oil bottleneck—the Strait of Hormuz—rises accordingly.

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