Weekly Offshore Rig Review: Into Iran

Worldwide offshore rig utilization dipped back close to the 83% mark this week, as six rigs in the Gulf of Mexico came off contracts, driving utilization down by a net total of three rigs.

With the recent fighting in southern Lebanon between Israeli and Hezbollah forces, the Middle East has been receiving much of the world's attention. As such, it seems time to examine the Middle East and Iran in particular, since it is the only major oil exporting country implicated in the conflict.

Persian Gulf Reserves
It has been common knowledge for many years that the Middle East is home to the world's largest resource base of oil. With over 700 billion barrels of reserves, the Persian Gulf states of Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE hold nearly 60% of the world's conventional oil. Between them, these countries pump close to one third of the oil produced in the world each day.

In addition to crude oil, the Persian Gulf states also hold about 40% of the world's conventional natural gas reserves with more than 2,500 tcf. With the massive amount of energy resources concentrated in these few countries, it is easy to see why they are so important to the entire world and why the world watches intently when conflicts brew in the Middle East.

Iranian Oil and Gas
Iran currently has the world's third largest proved oil reserves with 133 billion barrels, which is about half the reserves of the world leader, Saudi Arabia. Iranian oil reserves represents about 10% of all the oil in the world, a huge proportion for a country with less than 1% of the world's population.

As such, Iran is a major exporter of crude oil. Each day, the country produces just under 4 million barrels of oil. But, with consumption of just about 1.5 million bpd, Iran has the ability to export 2.5 million barrels of oil each day. This makes Iran the world's fourth largest oil producer and the world's 5th largest oil exporter.

In addition to oil, Iran also has the world's second largest natural gas reserves, with about 940 trillion cubic feet of gas. These reserves, which account for about 15% of the world's conventional natural gas, are largely concentrated in the offshore South Pars field. This one field alone contains as much as 500 trillion cubic feet of recoverable natural gas.

Given that 1 barrel of oil contains about as much energy as 5,400 cubic feet of natural gas, Iran's natural gas reserves account for the energy equivalent of about 175 billion barrels of oil. Combined with Iran's oil reserves of 133 billion barrels, Iran controls the energy equivalent of more than 300 billion barrels of oil. That puts Iran slightly ahead of Saudia Arabia's total hydrocarbon energy reserves, making it the most energy rich nation in the Middle East and second only to Russia in the entire world.

The majority of Iranian crude oil is produced from giant onshore fields near the Iraqi border. Most of these are older fields that have been producing for many years, and they are now in natural decline, with prodcution rates dropping an estimated 8% to 13% per year. Those decline rates combined with the relatively low recovery rates in Iran, which range from 24% to 27% (compared to 35% worldwide), indicate that significant investments need to be made in order to maintain Iranian oil production.

The Iranian Oil Ministry has announced in recent years that it plans to increase its oil production to 5 million barrels per day by 2010. This feat may not be realizable, but with the help of foreign investors and oil companies, it could be a reachable goal. And while Iranian law does not allow foreign companies to have direct concessions, they are allowed to invest in field development via a "buyback" program in which the government buys the fields back from the operators at a fixed rate.

Thus far, foreign investment in Iranian oilfields has been primarily focused on offshore fields. Since 1998, when the first foreign operated field came online, Iran has seen foreign investments being used to develop several offshore fields and increase production by several hundred thousand barrels per day. However, of Iran's 40 producing fields, only 13 are offshore, and only about 15% of Iranian production comes from offshore fields. So, the impact on overall production is somewhat limited.

Iranian Exports
As mentioned above, Iran is a major exporter of oil, with approximately 2.5 million barrels of oil flowing from its oilfields to other nations each day. About one third of those exports head for Europe, while the lion's share heads to Asia. Japan, China, and South Korea are the leading Asian recipients of Iranian crude.

Historically, Japan has been Iran's leading oil export recipient, given Japan's large demands for oil and limited resources. Recently, however, China has begun to catch up with Japan in terms of oil use. China's daily oil usage now exceeds Japan's, and its oil imports are growing very rapidly and likely to surpass Japan's in the next few years.

As such, over the last two years, ties between Iran and China have grown increasingly close. Iran is now China's second leading supplier of imported oil. In 2004, China and Iran signed two monumental energy accords which will deliver close to $100 billion dollars worth of Iranian oil and natural gas to China over the next 25 years.

Beyond hydrocarbons, China and Iran have also expanded their trade in other areas, with China selling electronics, consumer goods, and military technology to Iran. Politically, the two countries both share an interest in curbing Western involvement in Asia and the Middle East. And US foreign policy and sanctions have helped to drive these two nations closer together. These strengthening political ties and the growing military strength in Iran give the Iranian government more leverage in choosing its own course even in the face of growing pressure from the United States and Europe to discontinue nuclear activities. With an ally like China, Iran need not overly concern itself with what the rest of the world thinks.

Oil Tankers and The Strait of Hormuz
Between one half and two thirds of the world's oil moves by tanker each day. With the world consuming about 85 million barrels of oil per day, that means that between 40 and 55 million barrels of oil per day are being carried by tankers around the globe.

Of all the world's waterways, the Strait of Hormuz that connects the Persian Gulf with the Arabian Sea is the single most important oil transportation way. This narrow waterway separates Oman from Iran by just 34 miles. Yet, it carries the majority of Persian Gulf oil exports to the rest of the world, with about 90% of the region's exports traveling through this vital route. As such, 16 to 17 million barrels of oil are carried through this region every day.

This is another key area where Iran exerts a great deal of control. The country took control of three islands in the midst of the Strait in 1971 when its military forces invaded Abu Musa and the Greater and Lesser Tunb islands. The UAE and Iran held joint sovereignty of the islands until the early 1990s when Iran took control and claimed them as an "inseperable part of Iran." The Tunbs lie within 10 miles of the Hormuz shipping lanes, and as such, Iran has the ability to block shipping traffic from leaving or entering the Persian Gulf.

Conclusion
In many ways, Iran holds an enviable position in the world. It has the world's second largest combined oil and natural gas reserves, serving to fuel its economy. It has a strong and growing relations with China, the world's fastest growing economy and a likely future world superpower, serving to give it increasing political and economic clout. It has the ability to control all of the oil flowing out of the Persian Gulf via tankers, serving as a major deterent to any actions taken against the country.

At the same time, the country is extremely dependent on oil export revenues, which account for 80% to 90% of export revenue and almost 50% of government revenue. While the oil industry has helped the economy to grow about 5% per year, the country's inflation rate is near 15%. Iran is also suffering from high unemployment, which averages around 14%, and is much higher for young people.

With the need for investment to maintain and grow the country's oil production, it seems important that Iran be able to present a stable and investor-friendly image to the world. Acting as a pariah nation that boasts of nuclear advancements, sponsors insurgent and terrorist activities, and invites Western sanctions seems unlikely to help the nation achieve its economic goals. However, with the strengthening of Chinese relations, Iran may be able to continue to act as it pleases and still see the benefits of economic growth and advancement. Conversely, China's growing dependence on Iranian oil could drag the world's most populous country into the regional conflicts of the Middle East and vastly alter the political outlook for both Asia and the Middle East.

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Brent Crude Oil : $54.94/BBL 0.88%
Light Crude Oil : $51.79/BBL 0.21%
Natural Gas : $3.65/MMBtu 6.10%
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