Iran nuclear deal is ositive for the Indian oil and gas industry: ICRA

Iran is currently exporting 1 million barrels of oil per day (mbd), which is less than half of the 2.2-2.3 mbd that the country exported before the US and EU imposed oil sanctions in 2012. However post impositions of sanctions, dozens of Iran’s wells were mothballed and bringing them to production would involve fresh investments.

In 2006, the UN Security Council imposed sanctions on Iran following a report by the International Atomic Energy Agency (IAEA) regarding Iran's non-compliance with its safeguards agreement after the country refused to suspend its uranium enrichment program that the Western governments feared was intended for developing the capability to produce nuclear weapons. Subsequently the UN passed a series of resolutions imposing sanctions on Iran. Currently, the United States imposes an almost total economic embargo on Iran, which includes sanctions on companies doing business with Iran, a ban on all Iranian-origin imports and sanctions on Iranian financial institutions. In January 2012, the European Union imposed an oil embargo on Iran and also froze the assets of Iran's central bank. Subsequently Iranian banks could not take part in financial transactions with European and American banks and had minimal capabilities to purchase dollars and euros for foreign trade sanctions. As the sanctions were crippling the economy, after 23 months of negotiations, Iran has finally entered into an agreement with six world powers led by the United States, that paves the way for ending sanctions imposed by the US and Europe and also opens business prospects for the various countries including India. The agreement limits Iran's nuclear capabilities for a decade and puts in place a tighter inspection regime in return for lifting financial and military sanctions. However the lifting of sanctions would not be immediate as Iran would have to meet its commitments post which the IAEA would issue a final report which could eventually lead to lifting of sanctions. This is expected to be a time consuming affair and as per some media reports, the process could be completed only in the first half of 2016. Additionally the extent of compliance by Iran would continue to be a key factor for lifting of sanctions and subsequent non-compliance could lead to sanctions being reinstated.  
 
Iran’s oil export potential: Iran is currently exporting 1 million barrels of oil per day (mbd), which is less than half of the 2.2-2.3 mbd that the country exported before the US and EU imposed oil sanctions in 2012. However post impositions of sanctions, dozens of Iran’s wells were mothballed and bringing them to production would involve fresh investments. Accordingly it is estimated that about 500,000 barrels per day (bpd) additional production can commence by the end of 2015 and another 250,000-500,000 bpd by mid-2016. Accordingly over FY16-FY17 Iran’s production is expected to increase by about 1 million barrels of oil per day. Additionally the country has stored about 30 to 40 million barrels of oil in crude carriers in the Persian Gulf which would also come to the market upon lifting of sanctions.
 
With the global crude oil production at about 89 mbd, the additional Iranian production of 1 mbd adds only about 1% to the global production and about 2% of physically traded oil. However the additional production assumes significance considering the already over supplied market and the weaker than expected demand and would have a dampening effect on crude oil prices. While the extent of drop in international crude oil prices remains to be seen, the additional supply would cap any oil price rise in the foreseeable future. With the decline in crude oil prices, spot LNG prices would also tend to remain subdued in order to retain competitiveness with alternate fuels derived from crude oil such as naphtha and fuel oil. Importantly, with significant oil and gas reserves (proved oil reserves of about 158 billion barrels which accounts for 9.3% of global oil reserves; proved gas reserves of about 1,200 trillion cubic feet (tcf) which accounts for 18.2% of global gas reserves), Iran has considerable  potential to ramp up its oil and gas volumes in future. This, though, is contingent upon the oil & gas companies as well as service providers, typically based in US and Europe were to participate in their developmental programme. With falling E&P capex and lack of access to cutting edge technology, Iranian fields were in a state of decline and new fields were not in a position to be developed, which could change in a sanctions free era.
 
Impact on India’s oil bill: 
 
The domestic crude oil production of India met only about 21% of the domestic demand of crude oil in FY15 and lower crude oil prices would reduce the import and government’s subsidy bill. Every one dollar decline in international crude oil price reduces the import bill by about Rs 65 billion and the subsidy burden by Rs 9 billion. A decline in crude oil prices would also positively impact the current account deficit and keep inflation under control.
 
Impact on Indian Oil & Gas companies: 
 
With Iran being an important crude oil producer and exporter, India has had a long relationship with Iranian oil companies, with the relationship emanating in the form of crude oil imports, shipping of crude, equity stake in Indian refineries, participation in Iranian upstream ventures, export of CNG cylinders etc. The sanctions, therefore, negatively impacted a few companies in the sector. The following section analyses the impact on various sub segments of the domestic oil & gas industry.
 
Refining & Marketing: 
 
A decline in crude oil prices is positive for Indian refiners as their working capital requirements would reduce due to lower crude oil and products prices and lower gross under recoveries. Besides, additional sourcing from Iran would also result in lower freight costs and insurance costs due to proximity with Iran as compared to South America and African crude sources thereby reducing the refinery gate prices of crude oil.
 
Iran currently sells most of its crude exports to four Asian countries- China, India, Japan and South Korea. India which used to source over 10% of its crude requirements from Iran with Mangalore Refinery and Petrochemicals Ltd (MRPL) and Essar Oil Ltd (EOL) being the biggest importers, had reduced purchases to about 9 million tonnes per financial year, allowed under the sanctions. Post lifting of sanctions Indian refiners would be able to freely import from Iran. However Iranian crude was also attractive because of the sops that Iran was offering, which included a 3 month credit period for oil supplies, compared to 1 month which is the norm in the industry and concessional pricing of crude. This significantly buttressed the GRM of the concerned refineries besides aiding their liquidity position. The continuation of such sops would be critical in determining the economics of crude purchase from Iran with respect to competing crude sources. Nevertheless with the leadership aiming to increase production as fast as possible, crude could be attractively priced to regain lost market share in the initial few years, which will help GRM of the concerned Indian refiners.
 
Once the ban lifts Indian refiners would also need to make payments to Iran for their past purchases. Post February 2013 when the US blocked all payment channels, the Indian refiners have paid only 45% of the crude import bill in rupees through UCO Bank. The Indian refiners currently owe Iran about US$ 6.5 billion for crude sourced since February 2013, when payments through Turkey's Halkbank were stopped. Of this Essar Oil owes about $ 3.5 billion, MRPL $ 2.5 billion and Indian Oil Corporation $ 500 million.
 
Because of the sanctions, the affected refineries had significant difficulties in getting insurance/reinsurance from global insurance companies, for covering crude oil inventory during transit & plant & machinery. Moreover, the Indian shipping companies had similar issues in getting hull & marine insurance for shipping Iranian crude. The sanctions also impacted the fund raising plans of refiners (ECBs & Equity) such as CPCL, in which National Iranian Oil Company (NIOC) has a minority equity stake. These concerns could abate going forward thereby helping the affected refineries significantly
 
Exploration and Production: 
 
Decline in oil prices could be marginally negative for upstream companies such as Oil and Natural Gas Corporation, Oil India Limited, Cairn India given that the realisations on crude oil sales would also decline , though the impact could be partially offset with no material under recoveries. As per the latest under recovery sharing formula, in the case of PDS Kerosene, GoI would provide a subsidy of Rs 12/litre and the balance under recoveries would be borne by upstream PSU companies and in the case of domestic LPG, the entire under recovery would be borne by GoI.
 
Post lifting of sanction, Iran would also look to attract companies and investments to develop its vast reserves of oil and gas. In a bid to aggressively develop its reserves, Iranian Oil Minister has already met officials of top international oil and gas companies such as British Petroleum, Shell etc and the country also plans to launch a new upstream contract model in December. Once sanctions are lifted ONGC Videsh Limited (OVL) would also be keen to develop one of the largest discoveries it had made in an overseas block. OVL had in 2008 discovered the Farzad-B gas field in Iran’s Farsi exploration block in the Persian Gulf. OVL is the operator of the Farsi block with 40% participating interest (PI) in the 3,500 sq km block with another 40% PI being held by Indian Oil Corporation and the remaining 20% PI being held by Oil India Limited. The Farzad-B gas field may hold an estimated 21.68 tcf of in-place reserves, of which 12.8 tcf is recoverable. The consortium was to be paid a 15% return on investment once it was awarded development rights for the block. In August/September 2010, the consortium had submitted a revised Master Development Plan for production of 12.8 tcf of gas but had not signed the contract because of threat of sanctions by the US. In February 2012 the Iranian government issued a one-month ultimatum to the OVL-led consortium over the development of a gas field and in 2014, it put the field on the list of blocks to be auctioned in future though it did not cancel OVL's exploration licence for the Farsi block. However once the sanctions are lifted the consortium could face competition for development of the field from other global players. Nevertheless if the Indian consortium is awarded the development rights for the Farsi block it would be a positive for OVL led consortium as the field is approximately thrice the size of Indian’s largest field. Additionally domestic upstream and downstream companies would continue to scout for exploration and production assets in Iran given the emphasis on acquiring energy security and the large reserves of the latter.
 
Given that Iran has large oil and gas reserves, which it will try to aggressively develop and is being courted by several large oil and gas players, the lifting of sanctions on Iran would be positive for rig owners (such as Aban offshore Ltd, which already has rigs deployed in Iran) and upstream service providers as it would open up a large new market. Also as several fields in the Middle East are onland and in shallow waters, these would remain viable to develop even in a low crude oil and gas price environment.
 
Gas Transmission pipelines: 
 
The lifting of sanction on Iran may revive the long-pending gas pipeline projects such as the Iran-Pakistan-India pipeline or the Iran-India deep sea pipeline. However diplomatic hurdles, security issues and economics of the project considering low spot gas price environment might remain deterrents to the pipeline projects.
 
Other related industries: 
 
With the lifting of sanctions, the GoI is expected to also revive its plan to set up a fertilizer plant in Iran to reduce the reliance on imports of urea. Rashtriya Chemicals and Fertilizers, Gujarat Narmada Valley Fertilizers and Chemicals and Gujarat State Fertilizers Corporation had been nominated earlier by the GoI for setting up a 1.3 million tonne urea plant. The project will see an investment of about Rs 50 billion from India while Iran would offer long term gas contracts for the same. The gas would be the feedstock for production of Urea and the plant would be situated at Chahbahar in Iran. While several issues like gas price are yet to be ironed out nevertheless the lifting of sanctions would provide impetus to the project.
 
Earlier CNG cylinders manufactured in India were exported in large numbers to Iran, as the latter is the largest market in the world for CNG run vehicles. However with sanctions imposed by the US and European Union, Indian exporters (such as Everest Kanto Cylinders and Rama Cylinders) had to curtail their supplies to Iranian market. However with the lifting of sanctions the exports of CNG cylinders may resume.