By Mahmood Khaghani

From Nuclear to NewClear?

May 6, 2018

During the recent 4th Gas Production Sustainability Congress hosted by National Iranian Gas Company (NIGC) here in Tehran, Deputy Petroleum Minister and Managing Director of NIGC suggested the time is now right for a new policy of “Self Reliance” - (or perhaps a better translation is 'Resilience') for the energy industry.

Sanctions

He probably had in mind that President Donald Trump is almost universally expected this week to announce that the U.S. will leave the Joint Comprehensive Plan of Action (JCPOA) the spirit of which has been breached by the US since President Trump's election, by pressuring major banks and otherwise.  The mainstream expert view is that a snap-back on sanctions could disrupt in excess of 500,000 barrels a day of Iranian crude oil exports to Iran's economic disadvantage.

The JCPOA, endorsed in 2015 by Iran, the five permanent members of the United Nations Security Council and Germany, authorized the lifting of international sanctions on Iran in swap for fulfilment with limitations on its nuclear program. But, Iran's foreign minister on Thursday 3rd of May criticized USA President and said that Iran will not "renegotiate or add onto" the atomic accord. In a five-minute video message on YouTube, Minister Zarif also criticized Europe for offering the United States more concessions at Iran’s expense, and said:

"Let me make it absolutely clear once and for all: We will neither outsource our security nor will we renegotiate or add onto a deal we have already implemented in good faith."

Minister Zarif added more informally in language more understandable by President Trump

"To put it in real-estate terms, when you buy a house and move in your family or demolish it to build a skyscraper, you cannot come back two years later and renegotiate the price."

The global Dollar clearing system as a financial weapon:

The key institutions (Bank of International Settlement-BIS) World Bank, CLS Bank, SWIFT messaging system, Federal Reserve Bank, US Treasury, etc) of the global dollar economy and instruments ($ denominated bank credits, equity shares & derivatives) combine to enable the US to use the global $ clearing system as a financial weapon.

Iran has suffered from this financial weapon for decades and according to Chris Cook a Senior Research Fellow at UCL, Russia (thanks to US sanctions on the owner of Rusal, Oleg Deripaska) is now awake at the highest level to the clear and present need for a global payment & clearing platform no longer subject to domination by any nation.

What is Trump and his allies worried about? 

It is said that there is always the reason that people give and then there is the real reason. A cynical observer may say that the real reason for Netanyahu's obsession with Iran is that it serves as a distraction from what is essentially a real estate issue; in other words the need to acquire land and resources for an expanding population. The other side of this coin is that there are elements in Iran, particularly those who dominated the Ahmadinezhad administration, who have a vested interest in sanctions, through profits to be generated in bypassing them.

For Saudi Arabia the real reason is obvious: competition with Iran to sell oil; while for the US the need for energy security, and the profits of the US military industrial complex selling throughout the world increasingly complicated, outrageously over-priced and unreliable high tech weaponry.

Gas Wars

As with many regional countries, Syria is a country bounded by lines on a map drawn by British and French imperialists and which bore little or no relation to natural or ethnic geography.

The gas field located beneath the Persian Gulf is the largest natural gas field in the world. Qatar owns about two-thirds of this resource but can’t capitalise on it fully because liquefaction and tanker delivery over thousands of miles makes its gas more expensive than competitors in Europe.

Strategically, natural gas pipelines from the Persian Gulf must pass through Syria, and President Obama's strategy was to use petrodollars to fund new US production of shale oil & gas in order to end reliance on Saudi oil. Meanwhile, new pipelines were to enable the EU to access natural gas from Qatar (where the US established their biggest regional base) and from the Caspian, via the Southern Corridor.

President Assad, on the other hand supported another pipeline from Iran to Europe via Iraq and Syria and it was this which brought him into conflict with the US and their proxies.

Conflict or Cooperation?

The elements on both sides who opposed the end of sanctions for economic reasons naturally also support their reintroduction, but in my opinion while this suits private interests it does so at the expense of the public. I asked Chris Cook his recommendation to Iran if and when President Trump withdraws from the JCPOA.

“In my view, Iran has nothing to lose and everything to gain from staying in the JCPOA. In fact, at a time when the EU & other major nations are deeply unimpressed by self-centred US 'America First' economic doctrine, it makes geopolitical sense for Iran to deepen economic cooperation with other nations from within the agreement”.

Despite pressure faced by President Rouhani’s government from domestic reactionary forces I agree with Mr Cook that the smart policy for Iran is to continue as though nothing has happened and not only to continue in the JCPOA agreement but also to deploy energy diplomacy to actively promote new forms of economic cooperation agreements.

Energy for Peace and the concept of Energy Swaps

After the fall of the Soviet Union, times were hard, and the petroleum industry of Caspian littoral States was in deep trouble, both financially and environmentally, I was a member of a negotiating team from Iran’s Ministry of Petroleum that negotiated a 10% share-holding by NIOC in the Shah Deniz gas field. From this base, my colleagues and I developed an Iranian doctrine of energy co-operation through a range of innovative energy swaps such as gas for gas, oil into Northern Iran exchanged for oil delivered from the Persian Gulf (the Caspian Oil Swap); a gas for power swap with the Republic of Armenia, and the Gas for Gas swap with the Republic of Azerbaijan which became known as Energy for Peace.

Oil Market

Once again there are the reasons which market participants give to account for oil market price moves, such as stories about market share, inventory, speculation by hedge funds and investment, and then there are the real reasons of which there are two. Firstly, whereas one barrel of oil once fuelled the extraction of thirty barrels to fifty barrels of oil or even more, it is now often the case that one barrel of oil is sufficient only to fuel production of five barrels or even less.

This increasing energy intensity of production in turn leads to a declining Energy Return on Energy Invested (EROEI) which has now reached the point that at which it is increasingly economic to conserve oil using renewable energy or smart energy efficiency (the Fifth Fuel). This trend – which essentially caps the market price - is the reason why Saudi Aramco is selling ownership shares –which they would never do if they were optimistic as to the future price.

Secondly, there is market manipulation and as Chris Cook explains:

“Since 2001 the North Sea Brent/Forties crude oil contract tail traded on the Intercontinental Exchange (ICE – a market designed by Gary Cohn of Goldman Sachs in the interests of financial middlemen) has wagged the global oil price dog. Since then, using the same opaque prepay contracts used by Enron for a decade to defraud creditors and investors, oil has become a financial asset. So price volatility and absolute price levels now bear little or no relationship to the reality of actual product consumption and oil supply”

I observed to Mr. Cook that Gary Cohn recently resigned as President Trump's national economic adviser at almost the same time as Rex Tillerson (formerly of Exxon) resigned as Secretary of State.

“This is no coincidence. In my analysis both of them joined the US government specifically to put in place the new US energy strategy announced on 29th June 2017 as Energy Dominance. On 1st July 2017 Saudi Arabia ceased to price oil sales using the BWAVE benchmark price formula based on the cash-settled Brent Crude oil futures contract and switched to pricing against the daily Brent contract settlement price. Immediately after this a programme of purchases by unidentified funds began extending to over 1.4 million crude oil and products futures contracts (representing 1.4 billion 'paper barrels') and this led to the re-inflation of the price to current levels.”

I asked Mr. Cook why the US would do such a thing?

“Firstly, at over $65 per barrel US shale oil production is profitable, and investment in new production may be funded using petrodollars from the overseas producers who benefit from high oil prices. Secondly, in my analysis the US has now pegged the dollar directly to the oil price – in other words, the dollar is now on an Oil Standard. Thirdly, the US has created a Two Tier oil market where the US and allies benefit from top tier best prices and restrict access to antagonists such as Iran and Russia to a lower tier of aggressive pricing from sanction-proof buyers such as China.”

Finally, I asked whether he thinks this Energy Dominance strategy is sustainable:

“In the long term, there is the difficulty of maintaining a benchmark price based on declining oil production. In the short and medium term, the price increase since 1st July of $30 per barrel from $45 to $75 per barrel which has made oil exporters happy has made China (who is the world's largest oil importer) deeply unhappy at paying an additional $250m per day to producers.

China has built a strategic oil reserve approaching 1 billion barrels in not much more than three years, and were building reserves at the rate of 1.5m barrels per day in the first half of 2017. In the meantime they launched the deliverable Shanghai crude oil futures contract on March 26th. If I were in China's position, I would cease purchases of Saudi crude oil, which is aggressively priced against the manipulated Brent benchmark, and instead begin to buy crude oil priced against the Shanghai benchmark, probably in auctions. If producers refuse to sell at the Shanghai prices, China has plenty of reserves to fall back on.

In this way China, and possibly other oil buyers, could begin to reclaim market power from producers and the price would fall at least until producers reacted. There are signs that such a reallocation of Chinese buying may have already begun.

Transition through Gas

The idea of using natural gas as a 'bridge fuel' is not new. For resilience/self reliance reasons Iran decided two decades ago to switch from petroleum products to compressed natural gas to fuel urban transport such as taxis and buses, as well as freight transport. This freed Iran from importing expensive petroleum products for those fleets of vehicles.

Similarly Iran switched to natural gas as a feed-stock for petrochemicals and the outcome has been that the growth of natural gas production in Iran has been entirely used domestically to displace liquid hydrocarbons and free them for export.

The more expensive petroleum products become, the more profitable it is to substitute natural gas for these products, and that is why Iran should not only renovate existing CNG infrastructure but also extend it into marine use.  In other words, transmission of gas thousands of kilometres, whether by pipeline or by LNG tanker is not a smart strategy.

Energy Strategy - Organising Principle:

In the Caspian Region it is in the interests of producer countries like Iran to develop a resilient energy system enabling them to export more energy rather than consume more domestically.  In what way can this be attained? Producers should adopt an organising principle for policy of Resource Resilience: that is to say that for a given output of energy as a service (transport/mobility; heat, light and power) we must minimise carbon fuel use. We must also substitute renewable energy for carbon fueled energy and invest heavily in energy efficiency measures. This is in all likelihood what NIGC Managing Director meant when he referred to “Self Reliance”.

Energy as a Service

At the World Energy Congress (WEC) in Istanbul in October 2016, the tectonic shifts in global energy markets were discussed and one key insight which emerged was that electricity is better regarded as a service, rather than as a commodity capable of being transacted for profit. This reality is not well reflected by electricity market instruments and structures which have also been pursued by organisations such as UNECE. However, there are some interesting questions to be addressed, such as what would such energy market as a service look like?  Why would energy market participants wish to adopt it? And what would be the route of Road Map to implementation?

This is where new Smart Market financial technology comes in.

Energy Fintech

As Chris Cook puts it: “The current financial technology (Fintech 1.0) phenomenon of Blockchains and Coins has grabbed the world's attention by demonstrating that conventional financial instruments of debt, equity and derivatives are not the only options, and that Coin instruments operate outside the conventional system dominated by the dollar.

There are two fundamental problems faced by Fintech 1.0. Firstly, the key flaw of blockchains is that for every transaction the entire database of transactions is updated and encrypted. Secondly, the key flaw of Coins is that they represent proofs of past value transfer and energy use/expenditure conferring little or no rights over future value or energy use.

Nevertheless, in the same way that the flawed online businesses of the Dot Com boom two decades ago opened the way to Internet giants today, so it is that a new Fintech 2.0 wave may address the flaws in the Fintech 1.0 paradigm.

Energy Coins

When I spoke to him, Mr Cook had just returned from a conference in Moscow where he was invited by the Deputy Energy Minister for oil & gas, Kirill Molodtsov, to make a presentation entitled Energy Fintech – Beyond the Dollar

He explained that he had outlined to the conference how gas producers such as Gazprom, Rosneft & Novatek could issue gas credits (GasCoins) which are promises issued by producers in exchange for value received. The producers undertake to accept these credits instead of dollars, Euros, roubles or riyals in exchange for future supplies of gas and will mutually accept each other’s credits within a mutual assurance agreement and system GasClear.

The outcome is that instead of a conventional Coin which is simply an intrinsically worthless proof of past energy expended, the GasCoin may be used to pay for use of the intrinsically valuable energy content of future flows of natural gas and may be swapped for other flows of value.

It will be seen that energy credits may be independent of any jurisdiction and are complementary to existing financial instruments. The exchange value of different types of energy credits such as raw energy (oil & gas) or energy services (heat/cooling, transport & power) may be measured by reference to a constant and objective energy unit of account.

Energy Swaps – through the Golden Gate

The beauty of energy swaps which was demonstrated by the Caspian Oil Swap is that it is not necessary for chemical or physical energy to pass between two points when a flow of energy into one location may simply be exchanged a flow of energy out of another. In this way, EU energy security can be provided from the Caspian and Persian Gulf region through golden energy gateways of Iran and Greece via energy bridge nations such as Syria, Iraq, and Turkey etc. So by way of example, a flow of gas from Iran to Eastern Turkey could be exchanged for a flow of electricity from Western Turkey to Bulgaria and so on.

Transition through Gas:

During the recent 4th Gas Production Sustainability Congress in Tehran participants learnt how a  'transition through gas ' strategy includes the creation of new global gas market shared transaction data registry GasClear which may give legal effect available to gas market contracts without being bound by any particular jurisdiction. The market participants subscribing to a GasClear user agreement essentially consent to a gas market Club Rules.

Having created the market user agreement and 'club' of market participants it is then possible to introduce EnergyCoin/ GasCoin energy credits backed by mutual assurance, with risks & disputes managed, and standards overseen by a service provider within suitable governance arrangement which ensures that no group of market participants may impose themselves and their interests on any other.

Current transactional commodity markets such as oil & gas are dominated by physical & financial middlemen who require a great deal of capital to fund infrastructure and to take market & credit risk. But smart energy services on the other hand, require very little capital, and the transition from gas as a commodity to energy as a service may be seen as a transition through gas.

Smart Strategy

Apparently smart tactics – such as US sanctions on Iran – may often lead to counter-productive outcomes. So US physical sanctions led to Iran massively increasing self reliance and resilience across many fields of technology, particularly in the sciences, software and systems. Meanwhile US financial sanctions acted against corruption and minimised capital flight and in the views of some observers protected Iran from economic collapse. I asked Chris Cook his thoughts on a smart strategy for Iran at this critical moment.

“I believe that Iran should take advantage of President Trump's distaste for multilateral agreements and immediately challenge him to engage directly with Iran to negotiate a bilateral Grand Bargain. I think President Trump would find the prospect of leaving his mark on history -as President Nixon did with China - completely irresistible. The recent sudden transformation of the North Korean issue offers an insight as to the possibilities. 

In my view, President Trump is an unconventional businessman rational enough to understand the possibility of co-operation on objective costs such as resources and energy, while competing on subjective matters of faith and ideology.”

Smart Deal

Having had the opportunity of reading President Trump's 1987 book “Art of the Deal” and observed his behaviour in office it is clear that he does not operate within established international rules or norms.  Firstly, what he says is not necessarily what he does; secondly; whatever deals he strikes are always subject to change and renegotiation; third, he is not interested in detail; and fourth, he is uninterested in collective multilateral agreements and prefers bilateral agreements from a position of market power.

I believe that Iran is well placed to negotiate with the US using a different set of rules: where President Trump negotiates from a 20th Century perspective; Iran may negotiate with a 21st Century smart strategy based upon a transition from commodity markets and nuclear energy to services markets and a new global energy clearing system ('NewClear'); from dollar economics to energy economics; and from competition to cooperation, Iran may take a global lead.

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