Testimony For Presentation To
The Committee on International Relations
US House Of Representatives
July 23, 1997
Sarah Miller
Editor In Chief
Petroleum Intelligence Weekly
I wish to thank you for the opportunity to speak here today. I would also like to explain briefly the perspective that I will attempt to provide on the subject at hand, the impact of the Iran Libya Sanctions Act. The issue is an immotive one. It evokes strong and sharply conflicting views among various parties in the US government, in the governments it directly targets, in the home governments of companies potentially subject to its sanctions, and in the global oil and gas industry that is the primary tool selected to implement the goals of the law. I speak here today as a journalist and an editor representing an organization whose function is to provide informed and impartial reporting and analysis on the oil and gas industry worldwide. I do not speak as an advocate of any particular position.
That said, I would like to make two general comments on the historical and economic context in which this legislation arose, before discussing its specific effects as regards Iran and, secondarily, Libya. The first relates to the fact that the law narrowly pinpoints investment in oil as grounds for imposing sanctions against companies based outside the United States. At minimum, it seems ironic that the US should adopt a policy that is aimed specifically at restricting access by ourselves and our allies to oil and gas, in a region of the world in which the issue of paramount national importance to the US is unimpeded access for itself and its allies to those same resources.
To many, such brandishing of the oil weapon appears short-sited against the background of the specific targeting of the US, UK, and Germany when that weapon was first fired by the Arab League in the 1967 Arab/Israeli war and of the targeting of the US and the Netherlands when it was wielded to greater effect in 1973. I would note in passing that, for decades, the US has also been in the forefront of international opposition to secondary boycotts. The focus of that opposition was the sanctioning by the Arab League of companies which traded with or invested in Israel.
The second general point I would like to make relates to the changed state of world oil markets since 1990, when the disappearance of nearly 6-million barrels a day of Iraqi and Kuwaiti crude oil from world markets caused only a brief blip in the cost of gasoline to US and other drivers worldwide. As a day-to-day matter, I think most of you would view most of this change as positive. Private oil companies have been invited back in to many of the producing countries from which they were banished during the mass nationalizations of the mid-1970s. Stunning technological breakthroughs have allowed oil firms to pump more from old oil fields and more quickly find and develop new ones, both at lower cost. And partly as a result, global crude oil prices have been relatively stable at levels little different than those of 20 years ago in real terms.
However, there are also less benign effects from the decline of state oil monopolies and the new emphasis on near-term profitability that have accompanied this transition. One is that fewer companies and countries are willing to carry the cost of shut-in oil-field capacity. Another is that companies and countries -- the US included, as witnessed by sales from the Strategic Petroleum Reserve -- are loath to spend as much on holding inventory against that day when supply might be disrupted. Hesitance to spend money developing new capacity before it is evidently needed is reinforced by the fact that Iraq has roughly 1.5- to 2-million barrels a day in idle capacity that could be unleashed onto markets in fairly short order, should a change of government in Baghdad or other events bring an unconditional lifting of United Nations restrictions on that country's oil sales.
Given this new shortage of either spare production capacity or inventory, it can fairly be said that the only reason the unilateral US bans on oil purchases from Iran and Libya have not sent the world price of crude oil and the cost of gasoline to US drivers soaring is that the are unilateral. Should other importing countries suddenly decide to follow the US lead and thereby deprive markets of a combined 3.8- to 4-million barrels a day of Iranian and Libyan exports -- roughly 5% of total world supplies -- prices would undoubtedly rise sharply. And they might well stay high for an extended period.
The reason for this is that only Saudi Arabia and, to a minor degree Kuwait and the United Arab Emirates, still have surplus capacity that could be rapidly used to fill the gap. Even taking a relatively optimistic estimate for output potential, those countries could cover little more than half of the loss in exports from Iran and Libya.
What's more, the fact that US currently buys no oil from either of these countries and takes a decreasing portion of its supplies from anywhere outside the Western Hemisphere is irrelevant in terms of the price impact that loss of their production would have on US drivers. Oil is now closer to being a freely traded global commodity than at virtually any point in the history of the industry. Crude oil prices move more or less in tandem worldwide. Unless the US were to somehow re-implement domestic price controls, a virtual impossibility in light of its 50% dependence on foreign supplies and the certainty that investment in the domestic industry would plunge if it did, consumers here would feel the impact of a global price increase just as heavily as those in Japan, Germany, and other countries that are almost totally dependent on imported oil. Indeed, US consumers would probably feel it more, since the cost of the crude oil itself represents a much higher perecentage of the price actually paid by drivers at the pump in our relatively low- tax energy environment.
ILSA Impact: Iran
I will now move on to the specific effects of the Iran/Libya sanctions bill as regards Iran. It is undoubtedly the case that Tehran's effort to bring outside investment back into its petroleum industry have been hampered by the 1995 prohibition on US investment in Iran and the 1996 adoption of penalties on non-US firms which invest in large new projects in its oil and gas industry. With a few exceptions, oil and engineering companies still willing to even discuss projects in Iran are now much smaller and often less experienced than those which were in negotiation with Tehran prior to 1995.
British Petroleum, which began life as the Anglo-Persian Oil Company but which is now the largest producer of crude oil in the United States, has avoided any evident contact. Royal Dutch/Shell has continued to hold active talks with Iranian oil officials about potential large natural gas projects, while indicating that it is unwilling to sign binding agreements at this time. Italy's ENI, France's Elf Aquitaine, Australia's BHP, and several large Japanese oil concerns are among those that have disappeared from the roster of companies actively eyeing Iranian projects.
Of 11 large oil- and gas-related projects put out for international tender two years ago, none has yet been taken up by foreign investors. However, it's worth noting here that only three of these 11 projects are for oil or gas-field developments. The others were for refinery or other infrastructure work that provides scant attraction for international oil companies, even without sanctions attached.
One of the three oil-field developments included in the tender was for renovation of an offshore oil-producing platform, known as Soroush, that was damaged in the 1980s war with Iraq. In the absence of outside interest, that contract was awarded to a domestic company known as Iranian Offshore Engineering & Construction Company (IOEC). Recent agreement by a German banking syndicate arranged by Westdeutsche Landesbank to lend $90-million to IOEC for work on Soroush was, I believe, one of the events perciptating this hearing.
A second $140-million contract to develope the Balal oil field is still under negotiation by UK engineering firm Pell Frischmann and Canada's Bow Valley. Bow Valley President Walter DeBoni was quoted in PIW sister publication Energy Compass last week as saying that discussions on the deal are proceeding. But he conceded that "it may still fall apart," as a result in difficulties in obtaining finance. The final and largest of the three field development contracts, for a portion of Iran's super-giant South Pars natural gas field, is being pursued, but has not yet been signed, by France's Total.
That tender did not include the estimated $600-million Sirri oil and gas development taken up by Total after Conoco pulled out of the project in 1995 due to adoption of the Administration ban on US investment in Iran. Sirri remains the only definitive agreement signed by Tehran with a foreign oil company for some years, and because it was signed prior to passage of ILSA, Total's participation is apparently grandfathered under the act. However, Malaysian state oil company Petronas last year took a 30% stake in the project alongside Total, and the status of Petronas's investment under the act is murkier.
Factors Beyond ILSA
While no doubt gratifying for many of you here today, this litany of thwarted achievement by Iran does not tell the full story. Several other factors need to be understood to fully appreciate both why so little international investment has gone into Iran's oil and gas industry to date and why it could become substantially more difficult for the US government to keep a lid on that country's petroleum development in the future.
One factor which those analysing oil and gas developments in Iran from a political perspective often overlook is the unattractive nature of the investment terms that Tehran has offered to international companies relative to those available in many other nations. Iran launched its effort to attract outside companies back into its oil patch as far back as 1991. The aborted Conoco deal for Sirri in 1995 would have seen the first fruits of these efforts. For those four intervening years, no laws blocked even US companies from taking up the Iranian offer -- much less threatened sanctions against non-US investors.
The problem was simply that Tehran's offer was not competitive in the worldwide marketplace for petroleum investment capital. The international majors of the oil and gas industry tend to prefer what is known in the trade as "equity-style" arrangements to "service" deals. This means that they want a reasonably free-reign in how they operate oil and gas fields and that want ownership of the resulting crude oil or natural gas. They wish to take on part of the risk, in exchange for a potentially a higher return on their investment. By contrast, the projects offered by Tehran to date have essentially been service deals with fixed rates of return in the mid- to low-teens and restricted access to resulting oil and gas production.
It does not help Iran's cause that all of the properties it has put up for bid by foreign companies so far have been in its relatively sparsely explored and developed offshore sector. The onshore oil fields that provide the greater part of its existing output remain off-limits to outsiders. So it could be argued that the lack of foreign investment does not reflect the power of Washington so much as it reflects the failure of Iran to offer attractive terms and conditions for investment.
Tehran made just enough concessions on the rate of return and other technical issues in the Sirri contract to attract Conoco and, when that fell through, Total and Petronas. The Iranian government clearly hasn't provided juicey enough terms and conditions to lure others in. It would doubtless take even more concessions on Iran's part to do so in the face of US sanctions than it would without them. However, the argument goes, if Tehran made the terms sufficiently attractive, there might be little Washington could do to stop the stampede of foreign companies into the country. I don't know, because it hasn't been tried. I merely note that Tehran has that option in its arsenal, and it hasn't used it to any appreciable extent. It could do so at any time.
Natural Gas
A second factor that is likely to influence the ease and effectiveness of US sanctions over time is the prospect that oil developments will increasingly take a back seat to much larger and, from Washington's perspective, more problematic natural gas deals. While Iran ranks fifth in the world in oil reserves, it comes in second behind only Russia in the size of its gas holdings, and this enormous resource base has scarcely been tapped at all. The South Pars contract now awaiting signature by Total will, if the French company decides to proceed, be the first step down this road. The $2-billion value placed on that deal, compared to $600-million for the company's ILSA-grandfathered Sirri contract, provides just a hint of how big Iranian gas projects are likely to be.
Total's as-yet-unsigned South Pars deal gives it the right to develop two portions of that giant field. The gas would still belong to Iran and would be piped ashore and funneled into the domestic system and, possibly, exported in time to one or more of the countries on Tehran's extensive prospective customer list. Total would recover its costs plus a fixed profit margin in cash from the sale of liquids associated with the gas or, if that proved inadequate, from the proceeds of crude oil sales from other fields.
Even better representative of the Iranian gas deals waiting in the wings to complicate life for US sanctions enforcers is the $20-billion deal agreed to at a governmental level last year by Tehran with Turkey. Preliminary work is already said to be underway inside Turkey, as well as in Iran, on a pipeline designed to carry an initial 300-million cubic feet a day of Iranian gas to Turkey by 1999 or 2000, with volumes scheduled to rise to nearly 1-billion cubic feet a day six years later.
That's about the same volume that Total is expected to produce at South Pars if that contract goes through, and Iranian officials have indicated that the Total supplies would be targeted in large part at meeting its commitments to Turkey. The emergence of a new government in Ankara could lead to cancellation of this accord, but it has not done so to date. And Turkish officials have so far maintained that the deal is both too far along and too much needed to meet Turkey's burgeoning gas demand to make withdrawal practical. It would be neither simply nor painless for the US government to try to block such a large energy deal by an important ally which already claims to have been severely penalized economically by United Nations sanctions on Iraq.
Next on Tehran's list of chosen gas customers after Turkey is Pakistan and, beyond that, India. The governments of these neighboring rivals have been separately discussing potential gas purchases from Iran and other Mideast and Central Asian states for years. So far, their antagonism has blocked any serious talk of a joint project. However, that may be changing. Senior Pakistani officials have begun in recent weeks to talk openly of a willingness to see a pipeline from Iran extend on into India. Although New Delhi has yet to receive any firm proposals along these lines, senior Indian officials say that they would welcome such an initiative. Buoyant from recent Indo-Pakistani peace initiatives, both sides seem optimistic. And should Iranian gas manage to flow through Pakistan's territory into India, Pakistani officials such that Turkmen gas could also find its way to India.
Such arrangements must still be considered long shots against the background of decades of hostility between these two countries. But they no longer appear impossible. And a deal of this type could require Washington to choose between blocking an agreement with great potential for building ties between these two critical countries -- each with dangerous nuclear capabilities -- or altering its opposition to multilateral funding for projects involving Iran.
A Growing Far Eastern Role
All of which raises a third factor that may complicate the Iranian sanctions equation for the US over time. That is the likelihood that Far Eastern companies, many state-owned and all less readily subject to US pressure than their European and Canadian counterparts, will play an increasing role in Iranian oil and gas development projects. Besides its 30% stake in Total's Sirri project, Malaysia's Petronas has taken the lead in arranging potnetial gas sales in a consortium with Shell, British Gas, and Gaz de France that is eyeing a next stage in South Pars development beyond that already negotiated by Total. It is likely that this would be the gas targetted for sale to Pakistan and/or India.
Shell has clearly been unwilling to date to flaunt US sanctions by signing a large gas development deal. Given its large presence in the US, Shell might well continue to hold back even if such an enticing market as that of India and Pakistan combined were to open up -- particularly if sanctions are enforced against Total. However, Petronas is less likely to feel such compunction. China National Petroleum Corp., which has been mentioned as a possible substitute for Pell Frishmann and Bow Valley in Iran's Balal oil field, might be even less amenable to US pressure. And recent expensive forays by Beijing's top domestic oil producer into international projects as far afield as Kazakstan, Venezuela, and Sudan suggest that CNPC's ambitions in Iran might extend well beyond the relatively small Balal field.
The Caspian Factor
A final element that can only become more important to the Iranian equation over time is the role played by US sanctions in leaving the oil- and gas-rich former Soviet states of the Caspian region dependent on Russia for a supply route to the outside world. Numerous analysts with more impressive credentials than my own have stressed recently that Iran provides the natural alternative to Russia as a path to open waters for the enormous oil reserves currently trapped in Kazakstan and Azerbaijan.
I would merely re-inforce this with a couple of brief points. First is a fact that is evident but may have escaped wide attention in the discussion of Turkey as another competitor in the effort to get a pipeline built from one or both of these countries to the Black Sea, the Mediterranean, or the Persian Gulf. That is that Turkey shares no border with Azerbaijan, much less Kazakstan. To get from the Caspian to Turkey without touching Iran, a pipeline would have to go through either Georgia or arch Azeri-rival Armenia. Amoco, British Petroleum, and the numerous other companies involved in a giant oil development off Azerbaijan in the Caspian Sea clearly consider neither of these to be political feasible at this point. Either could become so in time, but this is by no means guaranteed.
In the meantime, Azerbaijan and Kazakstan -- which could concievable build a pipeline to Azerbaijan if that country had a route on to the outside world -- must look primarily to Russia to let their oil proceed to market. Moscow has been somewhat more amenable recently, but long-term success for such efforts requires both willingness on Russia's part to see large volumes of Kazak and Azerbaijan oil enter European markets in direct competition with its own exports and, in the case of Azerbaijan at least, willingness on the part of the Chechens to let such oil pass through their territory. What's more, the Western oil companies active in the Caspian region have repeatedly stressed their desire to have more than one route out for their oil.
Kazakstan has recently come up with a third alternative, but one which could carry its own set of drawbacks from a US persepctive. Almaty earlier this summer signed a $4.3-billion deal which gives China's CNPC a 60% holding in a domestic Kazak oil producer and the right to build an oil pipeline that would run 1,200 miles east to the Chinese border and from there, presumably, into China's fast-growing southern industrial region. Petronas is viewed as a possible partner in this ambitious project. Success for such a venture is by no means assured, with or without US sanctions. But neither can it be ruled out, given the technical and financial muscle of the parties involved and China's evident growing need for outside energy supplies.
In these remarks I have not dealt extensively with the prospective West LB loan to IOEC which is a key subject of this hearing, as I have no particular expertise on banking to bring to the subject. I am aware that this loan was made possible in part by agreement on the part of the National Iranian Oil Co. to assign funds from existing crude oil sales contracts for its repayment -- and that this is an aspect of its structure which may reportedly prevent the loan from being in technical violation of ILSA.
I would simply note that a repayment mecanism of this type has been suggested to Tehran by foreign oil companies and commentators in the past as a practical means for obtaining external financing, quite separately from any technical compliance issues it may raise under ILSA. And that a variant on it, in which oil traders and others function as intermediaries for what amount to advance sales of Iranian crude oil, has been widely used by Tehran to raise money in Japan and Europe for some years.
ILSA Impact: Libya
I will deal more briefly with ILSA as it applies to Libya, in part because several parallels can be drawn to the Iranian case. First, it is evident that, as with Iran, a blanket ban on US investment and trade with Libya, reinforced by ILSA and, in Tripoli's case by limited United Nations sanctions, has stunted oil and gas development to a degree. With the help of several European firms, Libya has managed to sustain its crude oil production at or near the 1.39-million barrel a day quota Tripoli agreed to within Opec. However, by the Libyan government's own admission, it has failed to push capacity much if any above this figure, despite internal predictions in the early 1990s that it would be able to pump 2-million barrels a day by 1994.
The most significant of several ongoing projects by international firms that should sustain and even marginally boost Libya's capacity by 2000 is a 100,000 barrel a day development of the Murzuk field by Spanish firm Repsol and partners OMV of Austria and Total of France. Like Total's Sirri deal in Iran, this project pre-dated passage of ILSA.
Despite evident attempts by Tripoli to draw in new oil-field investors, the onlycompanies that have signed up for new acreage in Libya since passage of ILSA are, once again, Malaysia's Petronas and, more unusually, private Saudi Arabian-firm Nimir. And even in this case there are mitigating factors. The potentially oil-producing property that these two companies have agreed to explore is in an offshore area controlled jointly by Tunisia and Libya, rather than in exclusively Libyan territory. And it seems unlikely that either company will exceed for some years the annual investment trigger for sanctions under ILSA.
In another parallel with Iran, natural gas could become a complicating factor if ILSA provisions on Libya continue over time and are strictly enforced. Italy's ENI has been inching forward for several years on a $4- billion scheme to pipe narly 800-million cubic feet a day of Libyan gas under the Mediterannean to Sicily and then on to the mainland. While ENI officials have periodically complained that US legislation is holding up their project, they also maintain that the scheme is grandfathered under ILSA, because it has been under way since 1990. The Italian company said late last year that it had already spent $500-million on the deal, mainly in route design and gas-field investigations.
Problems could also arise under ILSA with the Tunisian government, which in May reaffirmed its intention to move ahead with a $260-million venture to import smaller amounts of gas from neighboring Libya.
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