Iran’s long Term Energy Problems
None are more unjust in their judgments of others than those who have a high opinion of themselves.
Charles Haddon Spurgeon 1834-1892, British Baptist Preacher
While Iran has the world’s second-largest reserves of Natural gas and also one of the world’s largest reserves of oil the long-term energy situation here is far from bright. This is the lifeline of its economy yet the Iranian government is investing surprisingly rather small sums in maintaining the infrastructure and or increasing current production. Daily production is coming at 3.9 million barrels which is actually 5% under its OPEC quota; they have not been able to meet their quota for over 21 months now. Shortage of technical skills and huge delays in new projects are the main culprits for falling production. In fact, if nothing is done soon within a decade Iran’s net oil exports could fall to zero. Oil minister Kazem Vaziri-Hamaneh has stated that without additional new investment daily output could fall by as much as 13% a year more than double what outside experts had expected.
How did things get so bad?
The answer is rather simple; the Iranian government neglected this business for years. They treated it as a cash cow assuming that they could milk it forever without feeding it properly. Now the Cow is getting thinner by the day and could die of starvation in the years to come. The governments invest a measly 3 billion dollars a year; this is less than a third of what is officially required to increase production.
One of the main reasons for this is that local consumption is skyrocketing; petrol is sold at an unbelievable rate of 35 cents per gallon. This extremely low subsidised rate has driven consumption through the roof and has encouraged the smuggling of enormous amounts of petrol to the surrounding countries where it’s sold at current market prices. In fact, this low subsidised rate of petrol has encouraged anyone that can get their hands on some money to purchase a car and thus the situation continues to deteriorate. Once an exporter of petrol it now imports over 5 billion in gasoline a year because local demand outstrips local refining capacity.
The government is planning to build a new 16 billion dollar refinery, but this will only serve to further boost consumption unless prices are increased to reflect those of the market. One of the main reasons the government is reluctant to raise prices is because this would erode local support for them. A huge percentage of the population is unemployed and lives on less than a dollar a day and thus raising prices significantly would seriously raise the ire of the local population. To make matters worse, the President has increased public spending and handout programs by over 20% to roughly almost 220 billion dollars. There are several more programs that tie up an additional 50-60 billion dollars and without a huge increase in oil revenues Iran’s is going to continue to experience a budget deficit. Note too that Iran is adding 700,000 new individuals to the work force a year, but they have very few prospects of landing a job. Officially unemployment stands at 12%, but we estimate that it’s closer to the 20% mark.
In reality, Iran badly needs outside help but decisions related to oil and natural gas investments go through a maze of groups and this further complicates matters. From the outside, it appears that the decision-making process is haphazard and to large degree hostile towards western investments. For example decisions related to oil and natural gas investments are supposedly made by the oil ministry in union with the President and Iran’s parliamentary energy committee. However this is not the end of the slow process because energy plays such a huge role in Iran’s foreign policy other committees such as the parliament’s national security and foreign policy committees also have a say in such matters. Finally, let’s not forget how powerful the clerics are and in the end it’s stated that they are the ones that have the final say. Thus it become apparent that for something to move from the idea to the implementation stage is akin to the building of houses with one’s bare hands instead of using modern-day tools; a process that is not only slow but extremely inefficient.
Foreign companies are also reluctant to invest because of the increased possibility of a war with the United States. President Ahmadinejad increasingly antagonizing stance towards the United States and Western Europe has not helped attract new sums of foreign investment either. To make matters worse, Iran offers rather shoddy terms; outsiders are only contracted to drill wells and are offered only a small percentage of the profits while the rest goes to the government. This sort of tight-fisted behaviour is hardly going to attract the amount of foreign investments that are required for this country to maintain and increase its long-term production.
Long term the consequences are not very bright for if Iran were to stop exporting oil completely over 3.9 million barrels a day would vanish from the markets. We are not saying this would happen but if Iran does not invest substantially in expanding capacity production could fall to such a level that they have barely enough to meet their own needs. Thus precisely when the world needs more oil, Iran due to its lack of foresight will be taking off a substantial amount of oil away from the market. Such a development would only add fire to a market that has almost no extra supply; demand from China and India is expected to increase significantly in the years to come which means more nations will be competing for the same limited pool of oil.
Note also that the declining production in the oil sector also supports the claims the Iranians are making when they state they need nuclear energy to meet their energy needs. With nuclear power, they could free up quite a bit of oil and gas that is currently being used to generated electricity and meet other power needs. Yes, they could have simply avoided this situation by injecting the necessary amounts of money into their energy sectors but like all governments they waited too long to even come up with a coherent plan. Iran has spent almost nothing in upgrading its oil infrastructure since the fall of the Shah in 1979 and they are not willing to spend that kind of money now and wait 5-6 years to see the results when they could technically experience them a lot faster if they continue on the nuclear path. The IEA (International Energy agency) estimates that Iran will have to spend about 165 billion for it to have any hope of meeting the oil and natural gas production goals it has set for 2030. This is by no means chump change and amounts over 300% of the total oil revenues it earned last year. Energy consumption is skyrocketing and if they do not address these needs fast the current government is going to have a huge massive problem on its hands. The only way the mullahs are able to keep the population partly under control is through the funding of massive social programs and if oil revenues continue to decline then without nuclear power they could face huge amount of social unrest and this could be the foundation for toppling them over. Thus, they want to address their energy needs and do so as fast as possible regardless of the cost. The main criteria right now is time.
Iran is the only major oil producer that currently still suffers from a budget deficit. Most of the money to fund these social programs comes from Iran’s oil stabilisation fund which is supposed to provide a cushion to the economy in the event the country’s oil revenues drop. However oil revenues have been increasing every single year for the past 4 years; last year Iran was projected to have earned 49 billion dollars from selling oil and natural gas more than double its take off four years ago. Yet Iran has dipped almost every year into this fund to finance the budget shortfall; last year it spent 7.7 billion from this fund and most of it was on government subsidized programs.
For those who are investing in the energy sector, this is going to be great news and for those that have not well they will be part of the disaster equation. One must remember that one man’s disaster is another’s opportunity.
It’s for this reason we have taken so many positions in the oil and gas sector because we expect that the price of oil and natural gas are going to trade at levels that will make today’s prices look cheap.
We still expect that unless some massive breakthrough emerges in the energy sector that oil could be trading over 300 dollars a barrel one day and that Natural gas could trade as high as 66 dollars. The cost of one gallon of Petrol in Britain is over 6 dollars a gallon and in Netherlands it is 6.48 a gallon. Imagine how Americans would react if they woke up tomorrow and had to pay such prices; believe it or not this day is not that far off. Americans still pay one of the lowest prices in the world.
The oil and gas sector are going to be great investments for years to come. In between we might have to sell all our positions due to general market conditions but we will always be on the lookout for new entry points. In other words if the markets are going to melt down they will drag the good, the bad and the ugly with them and we do now want to sit through this. Thus, we will sell our positions and look for a bargain based new entry points.
Our advice to our subscribers is that they should get used to driving smaller vehicles; forget those big trucks unless you live in an area that really justifies their use. You do not need a huge SUV if you live in a big city; it makes no sense and it’s going to cost you a helluva lot of money in the years to come.
Note higher energy prices translate to higher prices everywhere and thus the effects of inflation finally are thrust right into the consumers face and this will be something that will take place on a global basis. In inflationary times precious metals usually shine and they shine very brightly thus as we have repeatedly stated in the past everyone should have some bullion (Gold and or Silver; preferably both) as a form of insurance.
Ignorance is never out of style. It was in fashion yesterday, it is the
rage today and it will set the pace tomorrow.
Other interesting articles:
Random Musings VII (March 22)
Housing Bust (March 22)
Overbought Markets (March 2007)