Subsidies and Sanctions: Iran gets high marks in IMF review. Energy Analysis by Mary E. Stonaker

Iran stands to gain $50 billion in increased energy revenues if drastic subsidy reforms are able to bring its gas prices up to Free-On-Board (FOB) Persian Gulf prices. Further increased revenues may double that figure, given continued strict reforms across its economy.

The International Monetary Fund (IMF) commended Iran’s initial efforts in a statement released last week, citing lowered average inflation rates and a “broad reorientation of the economy towards less energy-intensive products and services, and product technologies.” The evolution from a developing to a developed country, in economic terms, hinges on that move towards less energy-intensive industries.

With energy subsidies amounting to $101 billion, a bill approved by the Iranian parliament in January 2010 stated that such subsidies should be slowly removed to increase energy efficiency which will result in more energy available for export.

Before reform efforts, Iran’s energy intensity was four times greater than the world average. Despite only doubling its population over the past three decades, Iran’s energy consumption increased five-fold over the same period.

Iran’s energy sector suffered from state-controlled markets, inducing artificially low and unsustainable prices.

New policies aim to allow competitiveness, increased efficiency, and the entrance of renewable energies to the common marketplace.

Iran holds significant reserves of both oil and gas with proven oil reserves of 137.6 billion barrels and 1,045 trillion cubic feet (Tcf) of proven natural gas reserves. The geographic location of Iran gives it 40 producing oil fields both onshore and offshore as well as a majority claim to the largest proven contiguous offshore gas field, South Pars.

In 2008, Iran produced 4.2 million barrels per day of petroleum liquids, 3.9 million bbl/d of which was crude oil – overall five percent of the world’s production. As the world’s fourth largest oil exporter, Iran exported 2.4 million barrels of oil per day, mainly to Asia and Europe.

Despite these massive reserves, Iran announced its intentions to double its gas imports from Turkmenistan to 40 million cubic meters per day. This energy-rich nation was forced to import due primarily to the formerly high subsidy rates, which encouraged inefficient usage by Iranians, forcing them to import the balance.

Poor infrastructure development, caused by long-term sanctions, also eroded Iranian abilities to produce their own energy.

The 1979 revolution began an era of Iranian history, which saw devastation and neglect to energy infrastructure amongst others. Compounding the difficulty, Iran’s fields have a natural decline rate of about 8 percent onshore and 11 percent offshore without the use of EOR techniques.

Temporary solutions include increased investment in infrastructure of gas exploration and production, power generation and the transmission and transportation of energy types.

The problem with such “solutions” is that they do not address the heart of the problem: a lack of market-regulated prices which distort demand and continually create supply shortages.

Given its reserves, if Iran’s refineries received updated infrastructure and technology, Iran could potentially eliminate imports altogether.

Subsidies have been given to the Iranian people in various forms of either direct discounts or indirect support of a given commodity, such as petrol or electricity. Food and housing subsidies existed as well though this analysis will be confined to the energy sector. These subsidies, made commonplace after the 1979 revolution, afforded the leaders greater public favor, which translated into tighter control.

Gasoline consumption in Iran hovered around 400,000 bbl/d in 2008. Subsidies and increased industrial growth have increased demand over the past decade causing Iran to become a net importer. In 2009, 80 percent of Iranian imports were gasoline, at 130,000 barrels per day.

Iran’s energy subsidies have caused a national budget deficit along with the need for imports despite vast reserves and have left an economy unprepared for international market competition. The cost of energy to Iranians is often less than even the cost of production.

In the past decade alone, Iran’s oil consumption has increased 42 percent – the greatest consumer in the Gulf region. This figure can be compared to decreases witnessed in US (-4 percent), UK (-6 percent), Germany (-14 percent), and Japan (-21 percent) during the same time period.

High subsidies constituted a major stumbling block on the path to liberalization of energy markets.

As noted by the IMF, Iran has recognized that it is imperative that its energy sector open its markets to allow for a more efficient allocation of resources after many years of fruitless debates.

The aim towards open, internationally-competitive markets is where Iran faces a rather unique challenge.

The development of its nuclear program outside the purview of the IAEA caused concern in the west as to the true nature of the “could be weapons of mass destruction” technology.

Alternatively, however, the plants could be used peacefully to generate much needed electricity. It has served as an excellent source of clean energy across Europe yet the political nature of Iran has brought their nuclear intentions into question.

Sanctions against Iran’s energy sector have been in place since the 1979 revolution but more specifically since 1995.

Laws have been passed in the US forbidding American investment in Iran’s energy sectors as well as requiring the imposition of sanctions on any country investing more than $20 million per year in said sectors. Nations around the world have reduced investments though none have been hit with additional sanctions for this reason, yet.

Furthermore, the US has forbidden trade and investment with Iranian banks, thought to be linked to international terrorist groups. The European Union has forbidden its member nations to create joint ventures with Iranian companies or subsidiaries owned or controlled by the state.

The EU has banned any and all trade relating to infrastructure and equipment that may be used for energy-related or uranium-enrichment activities. The UN imposed sanctions on Iran for developing uranium-enriching equipment, which included travel and financial sanctions. Sanctions on Iran also halted talks of a pipeline from Iran’s Kish gas field to its LNG refineries and allow domestic production for power generation.

The debate as to the nature of Iran’s nuclear program will be left for now on this note – the technology has a great potential to serve as a clean means of electricity generation for Iran and the region. This would involve greater regional integration and cooperation in many aspects, especially with regards to infrastructure development. An electricity grid such as the GCC Grid across the Gulf could be constructed to supply neighbors with Iranian nuclear-generated electricity. Currently, though, this is still far in the future.

Sanctions limiting Western investment in Iran have opened the door to nations such as China, Russia and India, more concerned with their own diversified energy portfolio than with complying strictly, or at all, with international decisions.

Foreign private ownership in Iran is forbidden in the upstream subsectors in Iran. Instead, the government utilizes a system, known as “buy back,” which allows IOCs to explore and produce in conjunction with an Iranian counterpart.
In 2010, Iran’s Deputy Oil Minister in International Affairs Hossein Noghrehkar Shirazi was quoted saying, “Chinese companies have invested about $29 billion in Iran’s upstream oil and gas sector and another $10 billion in the country’s downstream energy sector, including gas, petrochemical and refinery construction projects.”

Russia, too, is subverting sanctions against Iran, signing a long-term commitment to invest in Iran’s energy sector in 2010. Iran’s first nuclear power plant, Bushehr, was built by Russians.

India has invested heavily in building the LNG port of Chabahar in addition to highway construction, linking Iran with Afghanistan. India has also been exploring ways to import Iranian gas, though complications and stumbling blocks in negotiations with their mutual neighbor, Pakistan, have stalled those particular pipeline talks.

International investment from China, Russia and India may be a great launching pad to integration but it may not be enough for Iranian markets facing heavy Western sanctions.

If Iranians had continued to consume at 2008 levels, they “would have diverted nearly 1 million barrels of oil from Iran’s crude oil exports to domestic consumption to satisfy demand.”

Decreased oil exports would weaken Iran’s position in OPEC.


While there is no international market for natural gas, uninhibited natural gas consumption would divert natural gas away from oil field injection and gas based industries.

The less gas available for injection into oil fields, the less enhanced oil recovery techniques would work. Carbon dioxide emissions, the highest in the region, would continue to grow and contribute to Iran’s already dire urban pollution quandary.

With energy subsidies amounting to $101 billion, Iran has worked carefully to decrease subsidies without upsetting civil order too much.

With subsidy removal, government revenue will increase and, it is proposed, be injected back into the economy. While the actual removal or reduction of subsidies will be gradual, the anticipated gains from such removal include cash payments to families, social security, health insurance, job creation as well as research and development funds.

If enacted and prices were adjusted to FOB Persian Gulf prices, Iran stands to gain $9 billion in gasoline revenues, $16 billion in gasoil revenues, and $25 billion in natural gas sales each year (totaling $50 billion).

After cash payments and reinjection into the economy listed above, at 20 percent, the next 30 percent of increased revenues will be used to increase the social infrastructure such as public transportation systems, power station efficiencies and water desalination plants.

Another 30 percent will fund research and development of construction, cooling and heating methods of its residential and commercial sectors in addition to efficiently utilizing renewable resources such as nuclear, solar and hydro power.

Finally, 20 percent will be re-injected into the national treasury to overcome Iran’s national deficit. This money would be returned to society, inter alia, through tax breaks to encourage adopting efficient though costly technologies in the home and office.

Potential trouble resulting from subsidy removal may arise from a variety of angles. First, there is no international market on which to determine gas prices, the fuel which constitutes 60 percent of Iran’s energy basket.

Iran must compete against gas exporters such as Saudi Arabia and Qatar which heavily subsidize their markets and receive gas at about $0.70 per cubic per cubic foot. The price of gas will directly influence the price of electricity as the majority of Iran’s power stations are gas-fired.

Far-flung gas trade is seemingly out of the question for Iran as it lacks the necessary Liquefied Natural Gas (LNG) infrastructure; to transport only 10 percent of its gas would require $8 to $10 billion investment plus 7 to 8 years in a cooperative world and market, analysts have predicted.

Sanctions and a volatile marketplace at the time of writing eliminate the last proviso of that prediction, increasing both capital and time required.

Iran must be commended for its efforts thus far toward overall market reform, especially that of its energy markets. Liberalization of markets is required to increase efficiency and prolong the life of oil and gas reserves, which creates higher energy security.

After market liberalization, Iran should turn its focus towards developing renewable and sustainable technologies, which may use strategic subsidies to gain entrance to otherwise liberalized capitalist markets. Its mountainous terrain provides ideal wind farm locations for it to take another step as a regional leader.

Lengthy investment and strategic development would be required before one can say that Iran has the potential to integrate into the global economy under the Western thumb of sanctions.

(Mary E. Stonaker is an independent scholar, most recently with the Middle East Institute, National University of Singapore. She can be contacted at [email protected].)