Iran fears falling oil sales – not UN sanctions

guardian.co.uk

With poor refining infrastructure and cheaper crude available elsewhere, Mahmoud Ahmadinejad should be starting to panic

The UN security council's latest sanctions against Iran are the toughest to date. While the country's public rhetoric has remained consistently defiant, Iranian officials admit in private that there is concern about the expected rise in costs and bureaucratic hassles for Iranian businesses. But they are quick to add that the latest resolution won't weigh down oil and gas projects much more than previous sanctions. The newest UN security council resolution will slow down development, but won't cripple Iranian energy.

What officials and technocrats working behind the Islamic Republic's complex and increasingly opaque oil sector are worried about is not sanctions, but the recent declines in oil sales to some off Iran's longtime international customers, particularly in Asia.

Iran is currently storing about 35m barrels of crude oil in offshore storage tankers, according to an Iranian official, who wished to remain anonymous.

Though the current storage level is certainly high, it's not excessive or abnormal for the Islamic Republic. Iran usually harbours high levels of oil in offshore storage facilities between the months of May and August, when the country typically conducts annual second-quarter refinery maintenance and witnesses a decline in sales for its heavier grades of crude oil. Offshore oil storage figures hit as high as 60m barrels in May 2008.

Oil officials have long maintained that crude in storage is always sold as soon as seasonal refinery maintenance operations are completed. What is unique this year, and a rising concern for Iran's oil ministry, is the decision by some of the country's important "eastern" customers, including China, India and Japan – who are among the main purchasers of Iran's heavier grades of crude oil – to either reduce their formal term contracts with the Islamic Republic in favour of better prices from other oil producers, or to cut some of their contracts completely.

Customers for Iran's heavier grades of oil are mainly companies from India, Japan, South Korea, China and south-east Asia, as well as Spain and Italy. China, India and Japan in particular have further reduced their purchases of crude oil from Iran during the past two to three months, according to the oil official.

Though weakening oil demand and conflicts over Iran's higher pricing are the fundamental reasons for the declines, the moves are being interpreted by Iranian oil officials as symbolic of an increased willingness by long-term international business partners to give in to US political pressure, and reduce dealings with the Islamic Republic until the controversial issue of its nuclear energy programme is resolved.

"There's an oil glut and this is a buyers' market, so if you can buy from anyone you want at a lower price and get brownie points with the US, then it's a win-win situation," says an Iranian government adviser.

If the decline in sales of Iraninan crude continues, with more "traditional" customers reducing their term contracts, Iran's National Oil Company will be forced to re-strategise how and to whom it will market its oil in the wake of tempered "eastern" oil demand and a global oil glut that has weighed down oil prices and encouraged a rise in OPEC supply to its highest level in more than a year.

This is crucial for Iran, whose ailing refineries can't refine the highly sulfuric and heavier grades of oil that make up a considerable portion of the country's oil exports.

Iran is attempting to close the gap between its inadequate refining infrastructure and enormously high domestic gasoline consumption, which requires importing up to 40% of gasoline demand, by making it a national policy to double refining capacity.

Though Washington's drive to ramp up sanctions against the Islamic Republic's energy sector has added urgency to the country's plans to expand and construct new refineries, members of the Iranian business community with ties to the oil sector have privately said that a number of Iran's refinery expansion efforts have either significantly slowed down or arrived at a standstill due to major declines in foreign investment and low access to international financing because of sanctions.

Only one refinery in Bandar Abbas, in southern Iran, can refine "Iran heavy" crude, but not other heavy grades of Iranian oil, such as Forouzan, which has a smaller market base of buyers who are able to refine it. Though Iran attempted to refine heavy grade Forouzan oil for the first time at its Bandar Abbas refinery in August 2008, it is unclear whether, and to what extent, the effort to refine the heavy oil was successful.

Thus, the National Iranian Oil Company is stuck in a paradoxical situation in which it is forced to refine a large chunk of its more expensive, better quality light-grade crude oil domestically into products such as gasoline and gasoil, which are then sold nationally at cheap subsidised prices, while having to export more of its heavier grades to an international customer base with a more limited appetite for heavier crude.

The rising sense of economic pragmatism within Iran's oil ministry is at odds with the free-spending policies of Mahmoud Ahmadinejad's government, which have left little money in state coffers for loans to the country's struggling private sector and increasingly appear to be made in isolation from Iran's economic realities.

"The president doesn't like to hear bad news. It appears the people around him don't tell him when there's something wrong," says the government adviser. "But there are others raising alarms about the economy. The government isn't panicking yet, but it should be."