Iran Works to Offset Sanctions' Effect

WSJ - With the European Union oil embargo taking full effect Sunday, Iran is stepping up its efforts to ensure its oil industry can withstand the sanctions.

At stake is whether Tehran can offset the effect of sanctions by bartering products for crude oil with China and selling more refined oil products such as gasoline to its neighbors. If it is unsuccessful, it may have to shut down some of its oil wells for a long period- a move that could damage reservoirs and push up global oil prices.

The EU embargo bans the purchase of Iranian oil and also prohibits insurance for tankers carrying Iranian oil, which affects the transportation of Iranian oil to non-European nations as well. U.S. sanctions that ban companies that conduct oil transactions with Iran's central bank from doing business in the U.S. took effect last week. The West is ratcheting up pressure on Iran as talks over its nuclear program have failed to make significant breakthroughs. The EU and U.S. suspect Iran is seeking to develop nuclear weapons. Tehran says its program is purely for civilian purposes.

Officially, Iran says it is fully prepared to deal with the sanctions.

"All possible options have been planned in government to counter" the sanctions, Iran's Oil Minister Rostam Ghasemi said Sunday in comments on the ministry's website. But Iranian oil professionals and experts say otherwise.

It emerged Friday that Iran's crude-oil production has fallen to its lowest level since 1989, just after its 10-year war with Iraq ended.

According to an estimate Friday by Vienna-based oil consultancy JBC Energy, Iran produced three million barrels a day in June. This compares to the 3.7 million barrels a day Iran was producing in 2010 when a ban, still in effect, on European investment in Iran oil and gas was implemented.

Iran's crude-oil exports, which comprise around half the government's revenues, fell by about 20% to 1.2 million to barrels a day in June compared to the previous month, according to preliminary estimates by a shipping tracker.

While Iran has yet to officially acknowledge the current decline, the head of the National Iranian Oil Co., Ahmad Ghalebani, Sunday said that crude-oil exports are set to fall about 20% to 30% in the second half of this year because of the EU embargo.

Iran said it can withstand the pressure and has a strategy in place to do so.

Mr. Ghasemi, the oil minister, said Friday that Iran is now exporting gasoline, compared with before the European investment sanctions took effect in 2010, when it was importing the motor fuel. This switch allows the Islamic Republic to earn a greater income per barrel from sales of higher-value gasoline to help cushion some of blow from revenue lost on crude sales as a result of sanctions. In the year ended March 19, Iran exported 382,000 metric tons of gasoline, including to neighboring oil producer Iraq, according to Iranian customs statistics.

The Islamic Republic has been strengthening its relationship with its biggest customer, China, which buys 500,000 barrels a day, according to the shipping tracker.

Beijing bypasses banking sanctions by paying Iran in its local currency, the yuan, which is then used by Iran to pay for oil services or equipment, Iran trade professionals said. India approved a mechanism for Indian oil companies to deposit payments for Iranian oil into rupee accounts, which then will be used by Iran to pay for agricultural products and medicines from India. The U.S. has exempted China, India and several other nations from U.S. sanctions.

Iran is developing other alternatives to maintain its production and offset lost crude sales. It is heavily investing in its refining and electricity sectors, which are fueled by oil and natural gas.

For instance, under its five-year development plan ending in 2015, the country plans to spend $47.5 billion in new refining and distribution and to boost its power-generating capacity by 40% or 25,000 megawatts. Much of this effort is geared toward exporting to neighbors that share a common land border with Iran, such as Afghanistan, Pakistan and Iraq, thus avoiding the sanctions that have affected oil shipments by sea. The banking sectors of these countries also tend to be less exposed to pressure from Washington because they have less business in the U.S. than the more developed countries in the eastern Asia.

In the year ended March 19, Iran increased its electricity exports by 30% from a year earlier, mostly to Iraq and Turkey, the country's Deputy Energy Minister Mohammad Behzad said in a recent interview.

Iran is preparing to build a fuel pipeline to transport jet fuel or gasoline to Afghanistan and is mulling the construction of a crude-oil pipeline to Tajikistan, according to Iranian press reports. It remains to be seen how successful that strategy will be.

Sanctions on everything from banks to equipment imports have increased the costs of producing and processing oil and natural gas in Iran. Tehran now has to use intermediaries to order products such as gas turbines or spare parts for its refineries and to make the payments, and that doesn't come cheap. For example, an intermediary abroad buying oil-and-gas equipment from a company that doesn't want to sell to Iran will charge 7% of the value of the equipment being purchased, an oil official said.

During its lifetime, a refinery will be 30% less profitable owing to delays and commissions paid to middle men to buy equipment and the lack of spare parts to maintain the facility in good condition, one contractor said.

Facing difficulties in transferring payments to Iran, China may struggle to find enough goods to compensate for its crude purchases.

"Iran cannot absorb all the value of its [oil] sales to China with imports," one Iran oil professional said. "And what it needs most is cash."

Iran imports goods from China as varied as cranes, automobile technologies and teapots, which are often paid for via special accounts where Beijing has deposited its payments for Iranian crude.

Indeed, experts are starting to say that Iran's already acute production decline could accelerate further.

Iranian oil officials and contractors said they are considering shutting some of its wells for temporary maintenance. But what is described as temporary may become permanent if sanctions last, they said. "That could damage reservoirs," an Iranian oil official said.