Energy markets – Iran in the lead?

December 30, 2015 - 0:0

After two years' discussion and postponements Iran’s new Petroleum Contract known as IPC was at last outlined at a very well attended conference in Tehran in late November. The skeleton contract will apparently be fleshed out in the coming months in further conferences.

However since the introduction of IPC the Petroleum Markets have moved on to the extent that oil prices have now dropped to levels that no oil producing nations ever anticipated. As Mehdi Moslehi a Director of UK's Petro Scotland pointed out in an interview following the COP21 Meeting in Paris: “The crude oil era - like coal - is coming to an end.”

In the last five years Saudi Arabia, saw fit to spend $520 billion in purchasing military hardware which has been deployed increasingly destructively and now finds itself with $100 billion budget deficit for 2015.

What are the implications of this profligacy for the oil market? Will Saudis keep pumping oil as fast as they can into an already saturated Market? How can Iran hope to attract investments in its upstream projects at these current low oil prices? What will be the role of natural gas in Iran’s current and future energy diplomacy? It is not easy to answer these and related questions within the constraints of this article.

Energy governance

It has been reported that Iran intends to dissolve its Ministry of Energy in the course of the next Five Year Economic Plan integrating it into the Petroleum Ministry. It is interesting that this is the mirror image of the previous administration's plan to dissolve and merge the Ministry of Petroleum into Ministry of Energy.

In the absence of an overall domestic energy strategy and foreign energy policy doctrine for Iran both approaches are in my humble opinion equally misguided. From the breakdown of the former Soviet Union, Iran's foreign policy was defined as “Energy Co-operation” and I am honoured to state that I was personally involved in this period of Iranian Energy Diplomacy.

During this period of Energy Cooperation Iran flourished despite the pressures imposed on its energy industry by increased domestic demand and external obstruction by foreign governments aiming to slow down Iran's economic growth.

In my view, the principal reason that Iran faced so many difficulties in its economy in recent years was not so much because of sanctions but was rather due to general mismanagement of the economy and in particular the misdirection of energy policy by those who owed their position to Know Who – rather than to technical Know How!

In fact, it is the case that sanctions have not had entirely negative effects in Iran. Indeed, I well recall an expert in markets and resilience - speaking at a major conference in late 2008 here in Tehran – observing how pleased his Iranian audience was that the US financial sanctions had acted beneficially to isolate and protect Iran from that year's global financial meltdown.

Moreover, in subsequent dialogue with me and others present at Iran Chamber of Commerce, Industries, Mines & Agriculture (ICCIMA) Education & Research Institute, he pointed out that if financial sanctions had not been in place to isolate Iran from hard currency accounts in Switzerland and other centres, then Iran's economy under the last administration could well have gone the way of post-Soviet Russia as profits from privatisation - and related corruption which has now come to light – would have drained from Iran.

Iranian and Western markets

Iran's current financial and banking system is a 'copy & paste' of a Western market model that is dominated by middlemen who buy from producers and sell to consumers with a view to making a profit. Whereas producers and consumers have an interest in stable and transparent prices, for middlemen, price stability and transparency are the enemy of profit. Therefore, middlemen will always resist transparency and stability in any country's economy. So, it is no wonder that we see after 5+1 agreement with Iran there are vested interest in Washington DC, Tehran and elsewhere – who profit from the existing sanctions - and who attempt to derail the agreement and prevent its implementation.

Nowhere is this more the case than in the global banking system which creates the credit necessary for trade and for the creation of new productive assets. Chris Cook who as a senior research fellow studies 21st Century Resilience Economy at University College London is of the view that:

“This global financial system is essentially dead. In 2007/8 the US dollar economy reached a point of Peak Debt at which the claims created by the banking system over US property owners became insupportable, and the bubble created by bank debt in US land prices remains unresolved to this day.

Since then, the massive boom in Chinese and Far Eastern production reached a point – exemplified by the astonishing statistic that China used as much cement in the last three years as the US did in 100 years – where the scale of demand upon finite global commodity resources meant that consumers had insufficient purchasing power to pay market prices.”

Mehdi Moslehi a Director from Petro Scotland in an interview with BBC Persian program had a similar perspective: “As Zaki Yamani put it, the Stone Age did not end for shortage of stones and the Oil Age will not end for lack of oil.”

In his view, as the era of oil comes gradually to an end Iran must plan a transition through gas to a low carbon and sustainable economy through initiatives such as Chris Cook’s concept of a Caspian Energy Grid. In their analysis, when the crude oil price passes $50/barrel:
(a) high cost oil capable of rapid production (e.g. US shale oil & gas) becomes profitable;

(b) renewable energy (the costs of which are falling due to improved technology) substitutes for carbon fuels; and above all

(c) the more expensive that carbon fuel becomes in dollar terms, then the more dollar profit there is in making carbon fuel savings – so-called 'NegaBarrels'.

They agree with other observers that the outcome of such sources of new production and demand reduction is that the oil price will in all likelihood never exceed $60 again for any length of time.
If it is indeed the case that the energy economy has reached a point of Peak Demand for oil then this has major consequences for Iran which in my view represent both a threat and an opportunity.

Rouhani’s choice

Rouhani’s government has a choice to make. Many of our Iranian university scholars, government officials, private business owners and ordinary people who wish to emigrate to the West, have been seduced into thinking that the Western market economy is in some way superior or desirable. But, during my exchange of views with Chris Cook who as a long-standing friend, observer and occasional adviser of Iran, he observed that Iran is now in many ways in a better position than had the sanctions never been in force. As a leading expert on markets, he says:

“In my analysis Western markets have now reached – in the Twin Peaks of Peak Debt and Peak Demand - the end of an era or 'market paradigm' and are poised to transition into a new era or paradigm which Iran is uniquely placed to lead.”

This perspective is entirely consistent with the view of myself and my colleagues during the tenure of the 8th government in Iran when the Petroleum Minister of the time “Minister Zanganeh” agreed the study of an Iran International Petroleum Exchange (Bourse) later established in Kish Island. The objectives of this Bourse were subsequently amended during later governments’ tenure in Iran and the name was changed to the Energy Bourse in Tehran.

As for its western counter parts the major shareholding and management control of the Energy Bourse lies with financial institutions whose aim is for government to abdicate its right to market and sell physical crude oil and to delegate these functions to this Bourse.

Many observers including myself are of the view that this approach essentially outsources Iran's domestic energy security to global markets and that government should consider carefully the wisdom of this approach. Fortunately, Minister Zanganeh has reappointed his former advisor who was responsible for the Iran International Petroleum Exchange (Bourse) study in Kish Island to coordinate and review matters in this regard. However, the rapid decline in oil prices and the high risks of haste appear to have reduced the pressure for urgent action, and allows time for reflection.

When those tasked with mobilising Iran's energy market infrastructure look to the West for guidance they will find in the current model of energy bought and sold as a commodity which Chris Cook suggests is a complete failure. He points out that: “ the Western market model operates not only against the interests of producers and consumers but even against the medium and long term interests of the competing middlemen who own and operate the markets.”

In this context I hope that current shareholders of Energy Bourse in Iran will consider seriously that Iran has gathered – by necessity of market exclusion through sanctions – expertise in other - off-market - ways of trading and these market methods are becoming more widely adopted.

So, for example in Iran's ground-breaking Caspian oil swap (regrettably suspended by previous administration) - a flow of crude oil into Northern Iran is exchanged for a flow of oil delivered in the Persian Gulf. This innovative policy was designed and implemented as a practical mechanism for energy cooperation during the tenure of Iran’s 8th government. It is pleasing to see it mirrored by a similar geographic oil swap between the US and Mexico.
Iran also pioneered energy category swaps, where a flow of one type of energy is exchanged for a flow of another. Here again during the tenure of the Iran’s 8th government minister of petroleum of that time “Minister Zanganeh” approved the innovative energy cooperation policy with Armenia which I am proud to say I personally worked on while in office.

The exchange/swap of Iranian natural gas for Armenian power was also an Iranian pathfinder in terms of energy market innovation and a memorandum of understanding was recently signed in Yerevan by the energy ministers of Armenia, Iran and Georgia, as well as by the head of Russian Networks Company. According to the memorandum, the four sides have agreed to establish a Coordinating Group, which will work towards the establishment of an energy corridor linking the four countries.

The role of governments in executing energy policy is changing rapidly and the Iran Chamber of Commerce, Industries, Mines and Agriculture (ICCIMA) is taking the lead in facilitating Business to Business (B2B) energy dialogue, investment and action within the Region and beyond. An important meeting under the auspices of the Economic Cooperation Organisation (ECO) is being co-convened by ICCIMA in Tehran on 18th/19th January and the above Yervan MOU may form a proof of concept of broader ECO energy cooperation not only with neighbouring countries but also more widely.

Back to the future

Such energy swaps and energy cooperation (energy diplomacy) are according to Chris Cook powerful but inflexible, and in his view the innovation which will mobilise next generation networked energy markets is the 'credit instrument' or energy credit. He defines this instrument simply as “a promise given by an energy producer in exchange for value received from investors of money or even money's worth of goods & services”.

Energy credits enable swaps or exchanges of the value of energy at any scale. In fact it was always intended that the proposed Kish Bourse (now the Energy Bourse) could become the market forum both for the means of delivering an 'energy dividend' to replace subsidies and a new means for popular investment in refineries, petrochemical industries, power plants, distribution networks through 'energy loans' repaid directly by the resulting flows of energy.

The proposal – which remains on the table – is that energy subsidies need not be paid to people in Riyals – thereby risking inflation – but rather through the creation and distribution of energy credits within an energy partnership framework. So how do energy credits work?

Firstly it is necessary to know what energy credits are not. Holders of energy credits may not demand money from the producer (e.g. NIOC, TAVANIR etc. So it is not a debt); they may not demand delivery of energy (from NIOC, TAVANIR etc. So it is not a derivative/forward contract); and holders do not have ownership rights in the energy producing assets (so it is not a privatised ownership share instrument).

Then what are they? I requested Chris Cook to explain: “the holder of an energy credits may simply present the energy credit instead of $, € or Riyals, in payment for supply of energy by the producer; he may sell the energy credit to someone else to present it; or he may invest in renewable energy and energy efficiency projects through energy loans with a return in the value of energy.”
He further added: “Students of financial history will understand that such credit instruments precede modern financial markets by thousands of years, but survive to this day only in dark and dusty corners of Islamic finance system.”

A modest proposal

As I mentioned above Minister Bijan Zanganeh has given Dr Mohammad Javad Asemipour the unenviable task of reviewing and mobilising Iran's energy markets. Dr Asemipour will recall supervising the work of the Wimpole International consortium with a company affiliated to Tehran Stock Exchange over a decade ago in respect of the establishment of the Iran International Petroleum Exchange (Oil Bourse) in Kish Island.

I am sure he was as frustrated as myself and the authors of this major study when the project was steered off course by a combination of blank official incomprehension of markets on the one hand and by vested interests on the other hand.

I asked Mr Cook to suggest a modest proposal for Dr Asemipour, by way of advice to Minister Zanganeh and the Energy Bourse, and with a view to integrating the original Bourse in Kish Island. His recommendations are as follows.

Firstly - the Energy Bourse to operate a wholesale 'spot' Iranian physical energy market hub for major public and private sector energy users.

Secondly - the original Kish Oil Bourse to be regenerated as a regional hub of a networked wholesale (B2B) financial market in energy credits, listing natural gas, petroleum product and electricity credits.

Finally - the Tehran Stock Exchange to list new classes of domestic Iranian retail energy credits for the general population, which would enable an energy dividend (replacing Riyal cash payment subsidies) to be paid effectively and without risk of inflation.

21st C markets - oil and gas as a service?

Implementation of the necessary infrastructure will not be completely straightforward, but Mr. Cook believes that Iran may take a global energy lead by stepping forward to embrace new markets, rather than stepping back to broken Western markets. Iran need no longer compete with other nations in a race to the bottom in selling oil and gas as commodities on an over-supplied market, but may enter into supply/swap agreements, so that consumers could obtain security and diversity of supply while Iran obtains security and diversity of demand.

By way of comment on this approach Sam Barden, a long time oil trader based in Australia says with reference to IPC:

“One important and defining point is that foreign contractors entering into Iran’s market will be remunerated on a fee per barrel basis, not a profit sharing agreement. This is in line with statements made by the Managing Director of the National Iranian Oil Company, Roknedin Javadi, that the IPC facilitates a service agreement as opposed to profit sharing.

This represents a small step towards the view of “energy as a service”, as outlined by Chris Cook and Wimpole International, however as long as Iranian oil is priced via London and New York, Iran will have no control over pricing. Iran needs a regional pricing mechanism for their hydrocarbons.”

Iran’s 'newclear' option

In summary, Iran is now well placed to lead the transition to low carbon economy through creation of a new 21st Century energy strategy and mobilisation of Iran's resources to implement this strategy both domestically and internationally.

The organising principle of this policy must in the view of several experts be the 'least carbon fuel cost' principle first publicly suggested by Dr Azizollah Ramazani of NIGEC in Ashagabat in December 2014. This is simply the principle that for any given amount of electricity, heat/cooling and power delivered, Iran must minimise the use of carbon fuels.

The financing and funding of delivery of this collaborative energy strategy – which builds upon previous energy co-operation - is in my view best achieved through the use of a new generation of energy swaps, credits and loans described above, and as with all such implementation prototypes or Proofs of Concept are necessary.

In the context of prototypes, the recent parliamentary delegation to Iran from Scotland raised the intriguing possibility that Iran's 60 year relationship with the Grangemouth refinery could be recommenced. Through an oil for product swap Iran's supply of oil would clearly be on fairer terms than those obtained from the historic sale of oil as a commodity to the vast profit of the Anglo Persian company (which subsequently became Anglo Iranian, British Petroleum and is now BP).

Closer to Iran, as I mentioned above, the recent news from Yerevan of a memorandum of understanding between Georgia, Armenia, Iran, and Russian gas interests as well as ECO new imitative for establishing ECO (B2B) Energy Consortium, opens up the possibility of new multilateral energy swaps and clearing arrangements which could lead the creation of new regional energy market infrastructure.

Perhaps during the 7th CNG conference will be held at Ministry of Petroleum Research Institute (RIPI) the ICCIMA Education & Research Institute on 18-20 January 2016 these concepts may be developed further?