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Iran And Future Developments In The Oil Market

By Seyyed Mehdi Hosseini
Middle East Economic Survey (MEES)
19 April 1999

There follows the text of a presentation given by Mr. Seyyed Mehdi Hosseini, Iran's Deputy Minister of Petroleum for International Affairs, at the Seventh Middle East Petroleum and Gas Conference in Bahrain on 12 April.

The international oil industry has faced various events in its century-old history. I do not wish to relate them. However those events have never matched today's pace of change. Today we witness an unprecedented momentum for transformation in the global oil arena, to such degree and caliber which may engender totally unique technologies, political and international relations systems and energy interrelationships. Events in the international oil market and the deterioration of the oil prices exhibited the vulnerabilities of all those investors which embarked upon huge investments of hundreds of billions of dollars developing high cost reserves. Such investors willingly spent over $16/B for these outlays in the 80's to carve up 60% of the global oil market share. They know very well that the recent technological breakthroughs which have reduced operating costs of the North Sea oil from $16 of the 80's to $7/B of today, as well as the vast efforts and huge investments on technical research and developments, provide no sufficient guarantee for their continued profitable output in those areas in the long term.

The crude oil output replacement via new discoveries has recently been down to some 20%. Today the reserves to production ratio (R/P factor) has fallen by 30% for almost all oil firms, vis-a-vis the 1980s. Exploring world class mega-fields is highly unlikely today.

All these factors have led the industrial world to reach a new assessment of the present environment, even taking into account the higher recovery factors in the fields which have now risen to 60% in many cases and 75% higher than in the 1970s on average.

The first victims of the low oil prices have been the high-cost producers of Alaska, Siberia, the North Sea and even the Caspian basin. Recently, the AIOC (Azerbaijan International Operating Company) has delayed further commitments with respect to its large-scale developments due to the soft market for oil and the high costs involved. Operations in other areas have been forced to scale down as well.

Let us assume that oil demand will continue to rise, that the economic downturn in Asia, Russia, Latin America etc. will finally subside, and that normal conditions will be reinstated. In that case, oil demand for such areas like Japan which had a negative growth and east Asian countries which had half the predicted growth in 1997 may not be considered the same, and under normal conditions, world energy demand would enjoy a 2% rate of growth per annum.

The recent oil price collapse has been so disastrous that even the giant producers have been deprived of the wherewithal to invest in their upstream sector. The good times of the 1980s, when the industrial world took the oil producers' capacity expansion plans for granted due to their oil-dependent economies, are now over. For today, we are witnessing massive deficits even in Saudi Arabia, making outside borrowing a distinct option for them. The plight of the non-OPEC producers is even more disastrous in the light of their higher operating costs and outlays, and incentives for investment in non-OPEC fields are now weaker than before or close to zero.

Such conditions paint a bleak picture in the years ahead when the world might face lowering output, unable to meet its increasing demand, hence giving rise to the possibility of another oil shock. We envisage two scenarios for the future:

1.The l980s experience would be repeated, in which companies invested in marginal, high-cost reserves, only to reduce reliance on low-cost oil particularly in the Persian Gulf area. This, as I mentioned earlier, is only feasible under high oil prices. Competition would be fierce in this case, and the Persian Gulf producers would be able to keep prices in higher ranges while gradually raising their market shares. This is certain and only natural due to the predictable reduction of non-OPEC output. We would then face greater research and development aimed at lowering costs and risks, thereby encouraging other energy sources.

2. Most potential investments, technically and financially, would flow to the low-cost fields, particularly those of the Persian Gulf.

The first scenario is less likely due to the course of events I mapped out. For its part, the industrial world now believes in the following:

1. Capital should logically go only to develop low-cost oil with a $2 to $3/B development cost as opposed to $6-8/B fields. Otherwise, we would have an abnormal situation which would correct itself sooner or later.

2. The world's reliance on the Persian Gulf is inevitable given that it has 70% of global oil reserves and 25% of gas reserves. The industrial world's presence here will simply be a function of its strategic goal to ensure international security of supply to moderate the positions of the regional states in relation to their contractual rights' provisions.

3. Low oil prices have dramatically reduced the potential for modernizing the industry and undertaking new exploration and development efforts and enhanced oil recovery in these countries. These factors, together with world economic crises, have set in motion a natural trend towards opening up the upstream sector to foreign firms in these countries.

I think the above second scenario is more likely in the light of current events. Oil companies are thus preparing themselves for the future. The recent mergers of BP Amoco and Exxon Mobil and others are the beginning of some kind of chain of developments which might also involve Shell, Texaco, Elf, Conoco and others. These are responses to future events. Such mergers have been clearly driven by the need to cut costs, share technological strengths, attain new markets, compensate for upstream losses and raise profits ­ all of which give rise to better organizational preparations for entering sizeable, low-cost and low-risk oilfield developments, particularly in the Persian Gulf countries where upstream closures to the foreign companies have hitherto been the main barrier to their entrance. Now, let us assume that this trend will reinforce other patterns I described earlier, thus directing a good part of the available investment capital to the Persian Gulf reserves and reducing the attractiveness of high-cost fields. In this case oil producers have two choices:

Firstly, to resist such a current: This scenario would have had the useful result of controlling the world energy market only in the long term when the world's reliance on these states would have risen naturally due to rising demand and decreasing non-OPEC output. The other natural consequences of such a scenario would be: higher oil prices; marginal fields becoming commercial; an upswing in exploration activities; and technological advances leading to lower costs and replacement by other sources of energy.

Secondly, to join such a pattern: It seems this is happening. If this is done consciously, taking into account national security interests, it may ensure producers' rights in contrast to a repetition of the past. I said that the face of world oil industry would be totally different in the future. It would be along these lines:

1.Rising demand, and higher oil prices.

2.Capital outlays would change course to low-cost reserves, particularly in the Persian Gulf.

3.Greater mergers and acquisitions among companies.

4.Upstream openings of big oil producers to oil companies' investments.

Now I would like to discuss my country, Iran, and its role and position in the future market developments. As a key player in the world energy arena, Iran has to recognize its resources, possibilities, limitations and the market outlook ­ particularly the determining moves in the market in the long term. It should define its role and contributions to the market, as well as its future course to enter a new era in the global economic and political age. What is crucial to know for us and the industrial world is that a return to the past is not possible and is not necessary. We call for global synergy, security of supply, and investments.

In a world ruled by competition, capital and technical know-how, as well as security for energy supply and investments, we are ready to expand such cooperation in well-defined relationships, and an appropriate climate acceptable to all global players. We have therefore designed buy-back contract models to break with the past and open up an appropriate basis along the following lines:

* Preserving sovereignty over hydrocarbon reserves.

* Attracting necessary funds to develop these oil and gas resources.

* Transparent definition of bilateral ties instead of entering risky arrangements.

* Outright production and income from the very first day of production.

* Technology transfers.

On the other side, companies' expectations with regard to achieving a satisfactory rate of return, together with long-term access to crude oil via long-term contracts and crude oil sales under international conditions are realized under this formula

This is a proactive stance with regard to future developments in the international oil market. It has been accepted by foreign firms despite earlier reservations. Other states, such as Syria and Kuwait, have somehow adopted this model in their foreign participation schemes too. The finalization of several contracts by NIOC may lead to the adoption of the buy-back model for contracts in the region and in future arrangements. So far we have signed a number of buy-back contracts for the development of our upstream oil and gas fields with various foreign companies including Total, Elf, Agip, Gazprom and Petronas. The most recent contract for the development of the Balal oilfield with Elf and Bow Valley of Canada was signed only 10 days ago. Our recent tenders for tens of projects are proceeding successfully and we expect to conclude numbers of these contracts in the very near future.


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